Y2K concerns might spur move on rates by Fed
By Brian Blackstone
DOW JONES NEWS SERVICE
NEW YORK -- At the Federal Reserve, the millennium could come early.
While most of us are counting the days till Dec. 31, the Fed may be eyeing
Aug. 24.
That's the date of a meeting of the Federal Reserve Open Market
Committee that some Fed watchers say could be the central bank's last
chance this year to tweak monetary policy before Year 2000 concerns
loom large enough to stay its hand.
Consider this scenario: the current economic climate of low unemployment
and robust domestic demand continues into November while some of the
factors holding down inflation, such as overseas weakness and the strong
dollar, reverse. The Fed could then be faced with unsustainably high rates
of growth with emerging inflationary pressures.
But any move to pre-emptively tap on the brakes to slow growth and
contain inflation would have outsized effects on financial markets jittery over
Y2K effects as well as on panicked consumers, who might be stockpiling
cash and even canned goods, bottled water, and power generators the way
they would for a major hurricane.
So if the Fed thinks the chances are good that the conditions for a tightening
will occur by year's end or early 2000, why not tighten sooner when
financial markets and consumers are better equipped to handle it?
''In our view, the Fed's window to tighten policy closes after the Aug. 24
Federal Reserve Open Market Committee meeting because of Y2K
issues,'' said Paul Kasriel, chief U.S. economist at The Northern Trust Co.
Economic shocks related to Y2K should result in a lot of ''noise'' in early
2000 data, Kasriel added, suggesting that Y2K could handcuff the Fed
until the spring of 2000.
That would leave just a handful of meetings to assess what Fed Chairman
Alan Greenspan and colleagues like to call ''the balance of risks'' to the
economy over the next year. The Fed has so far been able to avoid that
kind of pre-emptive thinking because there have been no tangible signs of
inflation despite three years of above-trend growth.
So far, the Fed's biggest Y2K concern has been operational -- ensuring
that banks are compliant with fixing the bug and that the banking system is
prepared for increased demand for cash.
The Fed has pledged to increase currency in inventory by one-third to
$200 billion by late 1999 to ensure that the banking system has enough
funds to meet what could be a huge demand for cash.
''We do not see any need for a vast surge in demand for cash late this year,
but if that should occur ... that responsibility will be met,'' Fed Governor
Edward Kelley said at a Y2K conference in New York this month.
From a policy standpoint, if Y2K were to accelerate a change in Fed funds
it would probably be a tightening rather than an easing. Indeed, an easing is
one of the short-term tools the Fed has at its disposal to soothe investors
and consumers in case Y2K-related fears intensify at year's end.
Besides, present economic conditions of very rapid growth and tight labor
markets suggest the odds are greater that the Fed's next move will be a
tightening.
In testimony last month, Greenspan said the Fed would ''continue to
evaluate ... whether the full extent of the policy easings undertaken last fall
to address the seizing-up of financial markets remains appropriate as those
disturbances abate.''
That statement fueled speculation that Fed could decide to ''take back'' its
last easing on Nov. 17 by raising the Fed funds target rate 25 basis points
back to 5.0 percent. The odds of that happening will increase if economic
conditions remain as strong as they are and inflation shows signs of
increasing, analysts say.
And if the Fed thinks the window on 1999 is closing, it could tip its hand
slightly through a change in its policy directive from neutral to tightening at
the March 30 Federal Reserve Open Market Committee meeting. That
would lay the foundation for a tightening later in the spring or summer.
But some economists don't think the Fed will be swayed by Y2K's effect
on market psychology. ''They're going to play Y2K in a real-time basis,''
said Ed Yardeni, chief economist at Deutsche Bank.
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