U.S. Economy: Fed's Dilemma Is Raise Now or Wait
Until August
By John Cranford
Washington, June 21 (Bloomberg) -- Emerging signs of slower U.S. economic
growth and low inflation give Federal Reserve policy- makers something new to
think about when they meet next Wednesday -- the presidential election.
Economic reports for May showed the first back-to-back monthly declines in
retail sales in two years and the lowest level of new home construction in a year,
as well as little change in consumer prices. That helps explain why 48 of 62
analysts surveyed by Bloomberg News are predicting central bankers will leave
the overnight bank loan rate unchanged at 6.5 percent next week.
Still, a decision to wait means Fed policy-makers risk the chance the slowdown
is temporary and they'll have to make the politically unpopular move of raising
interest rates at their August 22 meeting, days after Democrat Al Gore and
Republican George W. Bush begin their post-convention campaigns.
Fed policy-makers ``won't sit around the table and talk about the elections,'' said
David Wyss, chief economist at Standard & Poor's DRI in Lexington,
Massachusetts. Even so, ``it'll be in the back of their minds.''
The dilemma central bankers face is whether to raise rates next week to try to
pre-empt a threat of higher inflation or wait to see how enduring the slowdown will
be. After growing at a rate of 5.4 percent or more the last three quarters, the U.S.
economy is unlikely to slow to the 3 percent pace the Fed wants to see any time
soon, analysts say.
Rising energy costs, especially for retail gasoline, are expected to push up
consumer prices in the months ahead, and many economists say the Labor
Department's June employment report could show a rebound from May's
unexpected job loss.
Letter to Fed
Many in Congress say the Fed shouldn't even be thinking about increasing
borrowing costs. Just this week, 16 Democratic members of the U.S. House of
Representatives -- including Minority Whip David Bonior of Michigan -- sent a
letter to Fed policy-makers urging them to refrain from raising interest rates this
month for the seventh time in a year.
``It is now clear that an increase in interest rates at this time -- on top of the very
significant cumulative increase you have voted over the past year -- is likely to
lead to an unnecessary and socially damaging increase in unemployment
without any significant offsetting advantage,'' the Democrats said in the letter
sent Monday.
When the policy-making Open Market Committee in May raised the overnight
bank lending rate a half percentage point to 6.5 percent -- the highest in nine
years -- Senator Tom Harkin, an Iowa Democrat, called the decision ``clearly
excessive.''
Republicans were equally critical. ``Generally, I don't like interest-rate increases
when there is no inflation, and I don't like this,'' Senate Majority Leader Trent Lott,
a Republican from Mississippi, said after the May increase was announced.
Bush's Complaint
The Fed has been accused of helping scuttle presidential candidacies in the past
with its interest-rate decisions, according to an analysis by the Financial
Markets Center, based in Philomont, Virginia.
In 1992, when Republican George Bush lost his re-election campaign to
Democrat Bill Clinton, the Fed wasn't cutting rates fast enough in the wake of the
1990-91 recession, the group said. In 1980, when Democrat Jimmy Carter lost
his re-election bid to Republican Ronald Reagan, the Fed raised the overnight
bank rate to as high as 12.81 percent in an aggressive move to choke off an
inflationary surge. From May to October of that year, in the heart of the campaign
season, policy-makers boosted the rate 2.5 percentage points.
That's why Fed policy-makers might want to raise rates next week, rather than in
August, ``so they can't be accused of influencing the election later on,'' said
Robert Litan, director of economic studies at the Brookings Institution in
Washington. However, ``they'll go by what they think is best for the economy.''
After recent economic reports that point to the beginnings of a slowdown,
investors say what's best for the economy is for the Fed to decide not to raise
interest rates this time. The implied yield on the July fed funds futures contract,
which is tied directly to next week's Fed action, fell to 6.56 percent -- just above
the Fed's current target -- from 6.81 percent a month ago.
Greenspan Watching
U.S. central bankers, on the other hand, have made it clear they haven't called
an end to the course of rate increases that began a year ago. In the past two
weeks, 10 Fed policy-makers have spoken. They've been almost unanimous in
saying the economy is too vigorous for its own good, even with signs of slower
growth.
``There are a number of variables that would tell you, yes,'' a slowdown is
becoming visible, New York Fed Bank President William McDonough said on
June 13. At the same time, ``demand has to be brought down,'' he said. ``What
the Fed has to do is at the right time decide that the monetary policy tightening
in the pipeline is enough to achieve this goal.''
Fed Chairman Alan Greenspan was the only one who didn't use his public
podium last week to warn that inflation might yet be lurking behind the 4.1
percent unemployment rate -- almost a 30- year low. According to Argentine
Finance Minister Jose Luis Machinea, however, Greenspan said in a private
meeting that recent economic statistics might be overstating the slowdown, so
``you have to keep watching them because nothing is very clear at the moment.''
Several economic reports could push central bankers toward another rate
increase later this year. For instance, May's employment report, which showed
U.S. companies eliminated 116,000 jobs, could be reversed in June.
Bogus Report?
``We thought that was a completely bogus report and apparently the Fed did,
too,'' said Jim Glassman, senior economist at Chase Securities in New York.
The Fed's own report on industrial production showed a 0.4 percent increase in
May output against analysts' expectations of a 0.3 percent decline that were
based in part on the jobs figures.
And May's tame increase of 0.1 percent in consumer prices included a drop in
the price of gasoline, missing a 10-cent increase to $1.575 in the average pump
price per gallon of regular. Since the end of May, the average price of regular gas
has risen to $1.664.
If the Fed holds the overnight rate steady next week, they'll probably make it
clear in a public statement that there's a chance for more rate increases later.
``They may decide to wait, but they'll still point to an inflation risk and to
unsustainable wage growth,'' Wyss said. ``At the same time they'll point to
evidence the economy is slowing down.''
Then, the question comes down to what the numbers say in June and July. ``If
the numbers look bad enough, they can get away with it,'' Wyss said of an
August rate increase.
On the other hand, ``the slowdown is happening right on schedule,'' he said.
``They have a lot of room to maneuver'' if inflation stays tame. That could mean
``maybe no move until late in the year,'' Wyss said -- after the November election. |
