Debate likely before today's decision by Fed

Bank under pressure to pause in pattern of raising interest rates

others say stay the course

September 20, 2005|By William Neikirk

WASHINGTON — To pause or not to pause, that is the question facing the Federal Reserve today.

For 10 straight meetings, Chairman Alan Greenspan's central bank has gradually increased short-term interest rates in a campaign to bring them back to a more "neutral," or normal, level.

Another increase had been expected before Hurricane Katrina devastated New Orleans and the Gulf Coast - and sent gasoline prices soaring and consumer confidence sinking.

But now, the Fed finds itself besieged by pressure to wait until its Nov. 1 meeting before boosting interest rates again. Some analysts say it would be a horrible public relations move for the Federal Reserve to raise interest rates at a time of national disaster.

The Fed's policymaking arm, the Federal Open Market Committee, is likely to engage in an intense debate today before making its decision. It usually follows Greenspan's direction. Dissent has been absent since the Fed started raising rates.

The betting is on another rate increase of a quarter of a percent, the same amount interest rates have been raised during each Fed meeting since June 2004, largely because the central bank has noticed signs that inflation is beginning to re-emerge.

Janet Yellen, president of the San Francisco Federal Reserve Bank and an alternate member of the Federal Open Market Committee, said in a Sept. 8 speech that higher energy prices and less slack in the U.S. labor market appear to be increasing inflationary pressures.

Apparently anticipating criticism of another interest rate increase at this traumatic moment, she said monetary policy "has little scope to cushion the immediate economic fallout from such a severe and sudden blow to the region," meaning Hurricane Katrina. That is the job of government spending, she said.

The public and financial markets will be watching closely when the Fed makes its decision to discover whether the central bank will alter Greenspan's strategy of increasing interest rates at a "measured" pace.

The benchmark "federal funds" rate, which banks charge one another for short-term borrowing and is used to calculate all other short-term interest rates such as the prime lending rate, now stands at 3.5 percent.

Pause advocates

Those favoring a pause say that the economy already has begun to slow from pre-Katrina energy-price rises and that the economic climate is much more uncertain, given higher energy prices and increased unemployment. Higher interest rates could slow the economy more, they say.

The "pro-pause" advocates also contend that it doesn't make sense to lift interest rates higher as the federal government pumps billions of dollars to help rebuild New Orleans and the Gulf Coast. One arm of the government would effectively be working against another, they say: The spending would act to increase economic activity, and the higher interest rate could slow it down.

"They should pause and see what happens," said David Wyss, chief economist at Standard & Poor's, the credit rating company.

"If the Fed raises interest rates [today], it risks being seen as an unsympathetic institution after Katrina," said Asha Bangalore, economist at Chicago's Northern Trust Co. "Mr. Greenspan is much too clever to allow the world to describe his management style in this manner."

She said the Federal Reserve could release a carefully worded statement announcing a pause "when the risk of mounting criticism is very high." And, Bangalore said, new economic data show the economy decelerating. Only last week, the University of Michigan's consumer confidence index showed a sharp drop.

Opposed to pause

But those who believe the central bank should continue with its campaign say that the economy is still robust despite the blow from Katrina, and that a small rate increase would be unlikely to cause the economy to slow any more than it already has.

Brian Wesbury and Bill Mulvihill, economists at Claymore Securities Inc. in Chicago, said the Fed's benchmark interest rate is still below the "neutral" rate - the point at which the economy will continue to grow without creating inflation.

This key rate is below historical norms relative to the rate of inflation or growth in the economy, they said, adding that they believe that the "neutral" rate is a 5 percent federal funds rate.

There is wide disagreement over what the real neutral rate is. Some analysts believe the Fed has already reached it. Others say it is 4 percent and others 4.5 percent. The central bank hasn't given a clue as to where it believes this rate is. Greenspan testified on Capitol Hill this year that the Federal Reserve would know from the state of the economy when it had reached the neutral rate.

Wesbury and Mulvihill, like other analysts, said that if Greenspan and company take a pause now, it would establish a political problem for the central bank, since Greenspan's term ends early next year.

Greenspan "has the political capital" to keep boosting interest rates now, they said, but a new chairman might not have the clout to resist public pressure.

William Neikirk writes for the Chicago Tribune.

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