Fed will tighten Tuesday, or perhaps it won't

OUTLOOK

October 03, 1999|By Amanda J. Crawford

THE FEDERAL Reserve's Federal Open Market committee meets Tuesday to decide whether to boost interest rates for a third time this year. Last week a group of private and academic economists who call themselves the Shadow Open Market Committee, pointing to growth in the money supply, urged the Fed to raise rates further to head off inflation. But also last week, Federal Reserve Bank of San Francisco President Robert Parry said the central bank should be "more cautious" about raising interest rates because of the uncertainty of economic forecasts.

In a speech to the National Association for Business Economics in San Francisco, Parry cautioned that a pre-emptive policy can lead to the "wrong action" if the Fed is uncertain "about the underlying model of the U.S. economy." Parry stressed that the Fed is unclear whether the recent productivity upturn is "a cause or a consequence" of current U.S. economic performance -- and how long it will last. The uncertainty about productivity is the major uncertainty in the U.S. economic outlook, and for monetary policy, he said.

Which group has a better read of the situation? Should the Fed move now, or hold off?

Gerald D. Cohen

Senior economist,

Merrill Lynch, New York

My views would be much closer in line with President Parry. I'm not a big fan of basing policy on the money-supply numbers. The theory behind it is, if you have growth of the money supply, that is an indicator of stronger growth and higher inflation. That is predicated on the assumption that the velocity -- which is, in lay terms, the number of times money changes hands -- grows at a constant rate. And in the short run, velocity clearly does not grow at a constant rate. In fact, it's inversely related with money growth.

That said, we do believe the Fed is going to raise rates at one of the next two meetings. Although we feel that it will most likely occur at the November meeting, there is some chance the Fed could move Tuesday.

We believe the Fed's concern about the strength of economic activities and the possibility of inflation is overstated.

As Parry said, they are being pre-emptive because they don't currently see inflation.

We believe that the economy can grow between 3.5 and 4 percent without a step in inflation. Our forecast is for 4 percent growth this year. And we don't believe inflation is going to pick up.

Anirban Basu

Director of applied economics, RESI, Towson University

The Federal Reserve should hold rates where they are on Tuesday, and that is true for a number of reasons. First, though inflation is anticipated, it has yet to become manifest, and the Federal Reserve has already raised rates twice to pre-empt foreseen inflation.

Second, the recent action by the Federal Reserve coupled with concerns about upcoming earnings reports has already caused financial markets to turn lower. A rate increase at this time could lead to further deterioration in investor confidence. That would be a poor outcome at a time when we have already seen a fairly substantial market correction over the past month.

Finally, the Fed should not raise rates because their previous moves have already begun to have a slowing impact on the economy. Home sales fell slightly in August, and newspapers are reporting that help-wanted ads are starting to rise less rapidly, which means there are less people looking to hire.

That suggests that employers are becoming more cautious. Therefore, a further tightening would be excessive at this juncture.

I think, if it is going to be raised, it will only be by a quarter of a point, that is clear. But I think they may just let the market take a breath and not do anything now.

Scott J. Brown

Chief economist, Raymond James & Associates Inc., St. Petersburg

In the past, the Fed has often waited too late to raise interest rates and ended up raising them too much, eventually leading to recession.

Looking at the current situation, growth is still relatively strong, labor markets are tight, prices of raw materials are starting to increase. Normally that would be a call for some degree of action from the Fed.

On the other hand, the underlying inflation rate has actually come down a bit this year. The reason they cut rates last year was because credit markets had seized up.

The real fear then was that the economy would start to slow down significantly.

There is also a fear now because of Y2K that some of the credit-market participants will step away again and the financial markets will be less liquid. That means the Fed should be more accommodative than they would be otherwise.

You can make an argument that they should be more pre-emptive, but the Y2K concerns kind of force them to do nothing at this point.

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