August 20, 1999
Fed's Decision on Interest Rates
Won't Be as Easy as It Appears
By JACOB M. SCHLESINGER
Staff Reporter of THE WALL STREET JOURNAL
WASHINGTON -- For weeks, financial markets and Federal Reserve watchers have been in near-unanimous accord: The central bank, they predict, will nudge up interest rates Tuesday to keep the rapidly growing economy from overheating.
The dollar's recent slide against the yen would seem to underscore that view. Currency weakness tends to fuel inflation. A rate increase should both help firm up the dollar and keep prices in check.
Still, the closed-door decision among the Fed's policy-making committee might be a closer call than outsiders think. Chairman Alan Greenspan actually has left himself plenty of wiggle room to keep rates down. Fresh economic data over the past month -- from tame inflation to mixed evidence about worker wage gains to soaring corporate profits -- could be used to justify inaction, Mr. Greenspan's most recent public comments suggest.
Join the Discussion: Heading into Tuesday's meeting of Federal Reserve policy makers, how would you advise Federal Reserve chairman Alan Greenspan on U.S. monetary policy? Also, what long-term policy decisions would you advise him to make?
"The Fed has good reasons to tighten, but with inflation well-behaved, they have the option of waiting if they want," William Dudley, an economist with Goldman, Sachs, & Co., says. "We think they will [raise rates], but we don't think it's preordained."
Still More Braking Less Likely
Of equal importance, even if the Fed does end up acting next week, most experts expect the case against aggressive rate increases to be strong enough that officials will release an accompanying statement making clear that future increases are far from guaranteed.
The stock and bond markets long ago concluded that the Fed next week will lift its target for the federal-funds interest rate -- the rate at which banks lend to each other overnight -- to 5.25% from 5%. Futures trading markets Thursday put the odds of an increase at over 90%. Economists at 29 of 30 dealers of U.S. government securities see a move, according to a poll by Dow Jones Newswires and CNBC.
Next week's gathering of the Federal Open Market Committee will be the next round in the central bank's three-years-running argument over exactly how "new" the "new economy" is. For much of that time, the Fed has weighed in on the side of the optimists, leaving rates lower than the old models about the relationships between growth, unemployment and inflation would recommend.
But twice --- in March 1997, and again at the Fed's last meeting June 30 -- officials have tapped the brakes, fearing that the economy was reaching its limit.
Economy Is Still Racing
The case for a second consecutive rate increase next week rests on the view that nothing significant has changed since June -- that if the economy was driving too fast then, it still is.
In his most recent public comments, at a July congressional appearance, Mr. Greenspan explained the Fed's mindset this way: "If new data suggest it is likely that the pace of cost and price increases will be picking up, the Federal Reserve will have to act promptly and forcefully" to snuff them out. That, in the minds of most Fed watchers, is exactly what the data over the past month have shown.
One specific issue Mr. Greenspan raised in that testimony was whether growth would "persist" at its recent pace. Since then, the government has reported that businesses created a whopping 310,000 jobs in July, well above the 200,000 or so that analysts had been expecting; that industrial production last month jumped 0.7%, accelerating from the June 0.1% increase; and that retail sales, though moderating, also grew a decent 0.7%.
Even sectors that are most sensitive to rising interest rates show little evidence of slowing. Housing starts jumped 5.7% last month, despite the Fed June rate rise and the accompanying spike up in mortgage rates.
Wages Are Major Concern
The biggest "cost" increase that the Fed is worried about these days is wages. Here, too, markets have concluded the latest reports argue for an increase. The employment cost index, the government's broadest measure of labor costs, jumped 1.1% in the second quarter, nearly triple the first-quarter rate. Average hourly wages rose 0.5% in July, the biggest monthly jump since January.
Then there is the dollar, which is down this week against the Japanese yen about 10% from its summer peak. Among other reasons, the U.S. currency is being battered by improved prospects for growth abroad. The falling dollar makes imports more expensive. Higher global growth means, as Mr. Greenspan noted, that "the U.S. economy will no longer be experiencing declines in basic commodity and import prices that held down inflation in recent years."
Perhaps the biggest reason for raising rates is the very market expectation of such a move. If the Fed doesn't move, the stock market is likely to soar -- a response that would likely lead to even faster growth. And the dollar, which has already shown weakness with a rate increase assumed, would almost certainly plunge.
Still, Mr. Greenspan is one of the most dexterous two-handed economists around, and he also laid out a less-noticed "other hand" case against raising rates in his congressional appearances.
Considerations for a Plan B
Rapid growth and rising wages aren't, per se, bad, he suggested -- only if "productivity fail[s] to continue to accelerate" or if "imbalances" in the economy emerge.
The recent rebound in corporate profits seems to suggest that growth in productivity, or output for each worker hour, is showing little sign of slowing down. Second-quarter earnings for major U.S. companies soared 37% from a year earlier, according to a recent Wall Street Journal survey. Many analysts expect more of the same in the third quarter.
The statistics may show wages picking up, but the Fed's own survey of regional economic conditions published last week concluded "there have been only scattered reports of an actual acceleration in wages." And the wage data themselves may be suspect. The employment cost index was unusually muted in the first quarter; the second quarter spike may have been making up for a statistical quirk. Averaged together, the numbers show labor costs still were contained through the first half of the year.
Meanwhile, inflation has remained practically nonexistent. At the wholesale level, prices were flat in July, excluding the volatile food and energy sector. Consumer prices rose a modest 0.2%.
Deflation Is Bad, Too
That could make Mr. Greenspan hesitant to act too aggressively for a couple of reasons. The obvious one is that, for all the talk of "imbalances," the Fed's ultimate mission is inflation fighting, a battle that is hard to explain to the public when the enemy isn't visible.
Another reason is that Mr. Greenspan, having apparently succeeded in achieving price stability, is becoming increasingly mindful of the new complications that such stability creates for monetary policy. "Emerging adverse trends may fall on either side of our long-run objective of price stability," he told Congress, which, translated, means that deflation can now be as great a danger as inflation. "Both inflation and deflation create levels of uncertainty," he said. "Both must be avoided."
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