Fed's Guynn Says Rate Increases Justified by Inflation Threat
Atlanta, June 5 (Bloomberg) -- While there are signs the U.S. economy is beginning to slow, inflation remains a threat and the Federal Reserve's decision to raise the nation's benchmark interest rate by half a percentage point last month was justified, said Jack Guynn, president of the Federal Reserve Bank of Atlanta.
``While inflation has not yet taken root in the economy, the price increases we're witnessing in some sectors are an indication that inflationary pressures are emerging,'' Guynn said in the text of a speech to the Atlanta Treasury Management Association.
Friday's report that private employment fell in May, coupled with other recent statistics, shows that ``we may be beginning to see the economy approach a more sustainable level of growth,'' said Guynn, a voting member of the Fed's policy-making Open Market Committee.
Even so, Guynn's comments suggested it's premature to think rates have peaked, although he didn't offer an interest rate forecast.
The record U.S. expansion, now in its 10th year, will only continue if inflation remains low, Guynn said. Companies have been encouraged to invest in new plants and technology because core consumer prices have risen on average just 2.4 percent over the past five years. That, in turn, has helped raise productivity, enabling the economy to grow at a faster pace.
``But there are still physical constraints on how much the economy can produce, and if either the labor supply or productivity falls, or if other bottlenecks develop, we will reach those constraints sooner rather than later,'' Guynn said.
Risks Have Shifted
Given that, the FOMC's decision to raise the overnight bank lending rate to 6.5 percent on May 16 ``was the right decision,'' Guynn said, even though ``my phone calls and e-mails have been less `Fed friendly' the last three weeks.''
While rates have gone up 1.75 percentage points in the past year, only the last percentage point of tightening should be working to slow the economy, he suggested. The first 75 basis points simply took back stimulus the Fed provided following Russia's default in 1998, which threatened financial markets.
Now, the balance of risks to the economy has ``shifted away from an absence of liquidity and strains in the financial markets toward growing inflationary pressures,'' Guynn said. ``Those risks have remained.''
With Asian economies recovering, prices for imported goods are no longer falling. The price of oil and other commodities has been rising, forcing manufacturers to increase prices or cut profit margins. At the same time, ``we're beginning to see wages creep up, and benefits costs are moving up significantly, as well,'' Guynn said.
Measure of Determination
While increased productivity justifies some of those increases -- which have also helped fuel the expansion -- ``the downside, though, is than in an environment like this, it's much easier for manufacturers to pass on price increases, and for consumers to expect them,'' Guynn said.
Under those conditions, inflation can get out of hand unless policy-makers are vigilant, he said. ``That means my colleagues and I have got to continue to get our policies right,'' he said. ``Inflation, remember, only enters the economy when monetary policy-makers allow it to.''
The Fed's six rate increases over the past year ``should be understood as a measure of our determination not to let those things happen,'' he said.
Critics of those increases have shown why Congress and President Woodrow Wilson made the Fed independent in 1913, Guynn said. ``The Fed is independent because doing the right thing for the economy in the long run sometimes means doing the hard thing in the short run,'' he said.
``And doing the hard thing, raising interest rates, is not the kind of platform that wins you the immediate thanks of a grateful constituency or another term in office, even if it helps to extend the longest economic expansion in modern U.S. history,'' Guynn said.
No Imbalances
If the rate increases continue to slow the economy, capacity will continue to exceed demand and inflation won't take root, Guynn suggested. So far there are no signs of imbalances like excessive commercial real estate speculation or borrowing levels that are out of line.
Nevertheless, while Guynn said he doesn't ``see any of those kind of systematic imbalances,'' the low level of saving in the U.S. and the rising trade deficit ``could become an imbalance if we don't keep inflation in check.''
Shocks, like the oil crises of the 1970s and the Asian financial crises, can't be predicted, but ``can be managed or mitigated if we have our policies right,'' Guynn said.
An excessive growth rate -- 4 percent in each of the past three years -- is a risk, however, because shortages may develop if companies cannot meet the demand for goods and services. That would push inflation higher. ``If you take a speed bump at 15 miles an hour, after all, you're still moving forward. But the same bump at 70 will surely destroy your vehicle,'' Guynn said.
``Much, perhaps even most of our economy is new and improved,'' he said. ``But it remains vulnerable to the oldest enemy of all: inflation.''
Jun/05/2000 12:50 ET
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