Fed's Broaddus Warns That Overheating Economy May Spark Inflation
JAN 11,2000
RICHMOND -(Dow Jones)- The risk that the U.S. economy may eventually
overheat is rising, despite widespread expectations among economists of a
slowdown this year, a member of the Federal Reserve's policy-making Federal
Open Market Committee warned Monday night.
J. Alfred Broaddus Jr., president of the Federal Reserve bank of Richmond,
told a group of business executives that although forecasts of an economic
slowdown are "sensible," risks remain that the economy may grow too fast for
inflation to stay dormant. Broaddus is a voting member of the FOMC.
"Personally, I believe that the principle risk in the near-term outlook is
that continued exceptionally strong domestic demand for goods and services may
eventually cause the economy to overheat, and I think this risk is rising."
Given those circumstances, Broaddus said the Fed should continue to raise
interest rates preemptively to prevent an outbreak of inflation. The Fed raised
interest rates three times last year in preemptive strikes on inflation, and is
widely expected to continue its tightening stance again in early February.
"Acting preemptively means not waiting until inflation itself is clearly
evident before resisting it, if other indicators, like long-term interest
rates, are signaling a higher risk of inflation," Broaddus said. "History
teaches unequivocally that once inflation is evident in the economy, it is very
difficult for the Fed to bring it down without risking recession."
The comments suggest Broaddus may be inclined to support a rate increase
when the FOMC meets for the first time this year on Feb. 1 and Feb. 2.
Long-term U.S. interest rates, particularly the 30-year Treasury bond, have
been rising steadily in recent weeks and futures contracts on the key Fed funds
rate show investors are virtually certain of at least a quarter-percentage
point interest-rate increase on Feb. 2.
Broaddus, speaking to reporters after his speech, said "it's certainly
possible that part of that increase (in long-term rates) reflects concerns
among some market participants about the possibility of inflation."
The Fed official said he had no near-term fear of inflation. "While there is
some risk in the outlook, as always, I believe that prospects for continued
growth with low inflation in this first year of the new millennium are good,"
he said. "But sustaining this performance will require the Fed to shift its
focus from attaining price stability to maintaining price stability."
In particular, he said, the Fed should seriously consider the use of
"inflation targeting," in which the central bank would publicly identify the
level of inflation it considers acceptable and then tailor monetary policy to
attain that level. The European Central Bank and the Bank of England practice
inflation targeting, but the Fed's monetary-policy goals have historically been
more complex.
"I believe a strategy like this could significantly enhance the credibility
of the Fed's longer-term price stability goal, and as an important by-product,
give us greater flexibility to deal with short-term problems without risking
this credibility," Broaddus said.
Despite his worries about the risk of eventual inflation, Broaddus said he
doesn't disagree with consensus forecasts of economists. Those forecasts, he
said, call for the economy to slow to a growth rate of 3% in 2000 from about 4%
in 1999 while the unemployment rate holds steady at "a little over 4%."
Moreover, he said, the forecasts suggest rising oil prices will put upward
pressure on the consumer price index, "but this pressure is expected to
diminish as the year progresses." |
