Some hoping Fed doesn't overreach

The Economy

February 06, 2000|By William Patalon III

WITH THE juggernaut U.S. economy -- which Tuesday set a record for the longest expansion ever -- showing no signs of losing steam, a slowdown of any kind, let alone a recession, is near-unthinkable.

Consumer confidence is at record levels. Many workers are bettering their stations in life by changing jobs with nice raises. And the stock market has made Americans -- who in the early 1990s were economizing and flocking to cheap "private label" products in discount stores -- feel as if they can afford luxuries like that sport utility vehicle or move-up dream house.

While it's hard to label such spending as profligate, it still has the Fed plenty worried. In the past, such high levels of consumer demand would already have set inflation in motion. But this time, for lots of different reasons -- such as higher productivity, the "global glut" of cheap manufacturing capacity, and softness in other economies -- we haven't seen a rise in general prices.

But the Fed isn't waiting until we do: It raised interest rates three times in 1999 -- and then again Wednesday -- and most economists are predicting additional increases: probably one in March, perhaps another in May, and possibly more before 2000 comes to a close.

It's this potential for still more rate increases that has some economists hoping the Fed won't be too aggressive. Since it can take anywhere from six to 18 months for a rate increase to really make itself felt within the economy, there may be a risk in the central bank boosting interest rates again and again -- before it can see just how much of an impact its previous actions have had.

In short, as it works to nurture the expansion by blunting inflation, could the central bank "tighten" credit too much, dampening -- or even halting -- the expansion?

"That's always a danger," says Donald Ratjczak, director of the Economic Forecasting Center at Georgia State University's College of Business Administration in Atlanta.

Make no mistake: The Federal Reserve, under Chairman Alan Greenspan, has been mostly masterful:

It deftly sidestepped a recession by pumping money into the economy after the crash of 1987, and it cut rates three times in 1998 to help avoid a global economic breakdown after Asia, Latin America and Russia were all singed by the "Asian contagion," and after the collapse of the Long-Term Capital Management hedge fund threatened the world's financial system.

Until last week, when the Fed raised the federal funds rate for the first time this year -- the fourth time since June -- all the central bank had essentially done was to take back the three rate cuts of 1998. The three rate increases of 1999 -- June 30, Aug. 24 and Nov. 16 -- appear, to date, to have done little to take the sizzle out of the economy. But in its continuing campaign against inflation, the Fed will probably continue to raise rates.

Last week's quarter-point increase was likely needed, and more may be, too. But remember, it's been just a little more than seven months since the first increase, the central bank has tightened credit four times, and it appears poised to do so again. It's fair to say that the full impact of these rate increases has yet to be seen: And being too quick to raise rates in the next few months could end up being akin to speeding down a winding, country road -- at night -- without headlights. In neither case can you really see what's ahead.

The Fed "is definitely snugging up on [interest rates]. But the economy is growing quite strongly," says Gerald D. Cohen, senior economist for Merrill Lynch & Co. in New York City, and a former Fed economist. "I think it's important that the Fed raises rates. I don't think this has been too much of an application of the brakes -- but patience is important."

Though the Fed has complex economic models that tell it how the economy should react, managing an economy is not an exact science. What's more, there's always the chance for a wild card -- an unforeseen event that "shocks" the economy into a slowdown.

That's just what Saddam Hussein's invasion of Kuwait did: It caused a huge jump in oil prices that, accompanied by still-tight credit (though the Fed was by then lowering rates), helped topple the U.S. economy into a recession that the country -- and particularly Maryland -- was slow to recover from.

Today, with energy prices already high -- crude oil prices have doubled in the past year -- it might take only a supply-squeezing political problem in the Middle East to prompt an overnight spike in the prices of oil and gasoline. Think about what that would do: You'd wake up one morning and it would suddenly cost more to ship products, to travel for business or pleasure and even commute to work.

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