the future is bad:
Fed Doesn't Change Interest Rates;
Policy Makers Lean Toward Increase
By DAVID WESSEL
Staff Reporter of THE WALL STREET JOURNAL
May 19, 1999
WASHINGTON -- The Federal Reserve decided to leave benchmark interest rates unchanged, but said it is so "concerned about the potential for a buildup of inflationary imbalances" that it is leaning toward raising rates in the coming months for the first time in nearly a year.
Although inflation remains "generally ... quite subdued," the Fed said in a 134-word statement, "domestic financial markets have recovered and foreign economic prospects have improved" since it slashed rates by three-quarters of a percentage point last fall. It also suggested that demand in the U.S. economy is growing faster than the economy's ability to supply goods and services, despite gains in productivity.
The Fed's decision to adopt an end-of-meeting statement, or directive, that says a rate increase is more likely than a rate cut doesn't mean that higher rates are a certainty. Rather, it is a clear statement that Fed officials at this moment see a much greater risk of accelerating inflation than of a worrisome slowdown in the economy.
In March 1998, for instance, the Fed adopted a directive that said it was leaning toward higher rates. But after Russia's default and devaluation shook global financial markets in August of that year, the Fed actually ended up cutting rates. According to a tally by economists at Goldman, Sachs & Co., the Fed under Chairman Alan Greenspan has ended 29 of its policy meetings with a bias toward higher rates. In half the cases, rates were lifted within six months, and in the other half rates weren't.
Stocks Fall
Financial markets reacted negatively to the news. The Dow Jones Industrial Average, which had been up nearly 70 points before the 2:15 p.m. Eastern time announcement, quickly reversed course and ended the day down 16.52 points at 10836.95.
Treasury bonds, which also had been higher during the day, fell after the announcement and ended the day little changed. The yield on 30-year Treasury bonds was 5.88%. The reaction might have been sharper if not for a May 6 speech by Mr. Greenspan and last Friday's unanticipated uptick in consumer prices, both of which led many Fed watchers to predict Tuesday's outcome.
The decision leaves the Fed's target for the federal funds interest rate at 4.75%, the level at which it has been since November. The Fed manipulates the fed-funds rate, at which banks lend to each other overnight, by buying and selling government securities. The Fed Tuesday left unchanged the discount rate, at which it lends directly to banks.
The Fed's policy-making Federal Open Market Committee traditionally ends each session with a statement on where it believes rates are headed in the weeks ahead. In the past, the statement was supposed to be kept confidential for six weeks, although the press sometimes reported it earlier and Fed officials sometimes gave away the secret in speeches.
Move to More Openness
But the Fed has moved slowly toward more openness. In 1994, it began announcing changes in its target for the fed-funds rate, but it offered explanations only when changing the target. Then in February, it said it would reveal the directive and explain its thinking "when it wanted to communicate to the public a major shift in its views about the balance of risks or the likely direction of policy." Tuesday's statement was the first use of that new tool.
When they met in early February, according to a summary of the meeting released subsequently, some Fed officials were already prepared to undo some of the rate cuts implemented last fall amid turmoil in the global economy and financial markets. Since then, the economy has proved much stronger than expected, the stock market has continued to climb and foreign economies have improved. Except for one month of bad consumer-price numbers, tangible signs of inflation have yet to emerge.
Yet the much-forecast slowing of U.S. economic growth has yet to arrive, causing concern at the Fed that the inflationary good luck may be running out. The Fed statement is a sign that, with the jobless rate already at a 29-year low, FOMC members won't wait forever for the slowdown to materialize. The decision to hold rates steady for now, and the statement's reference to the possible need for action in the "coming months," suggests the Fed is willing to wait a little while longer, though.
"Against the background of already-tight domestic labor markets and ongoing strength in demand in excess of productivity gains," the Fed statement said, "the Committee recognizes the need to be alert to developments over coming months that might indicate that financial conditions may no longer be consistent with containing inflation."
Richard Berner, chief U.S. economist at Morgan Stanley Dean Witter & Co., said the statement is the first step toward tighter monetary policy. "The basic point is that the inflation risks, while relatively small, are rising. Last fall's easing was put in place as we witnessed a drying up of liquidity in domestic financial markets and prospects for the global economy were deteriorating." With both those concerns abating, "it's appropriate for the Fed to take back some of the easing that they put in place last fall."
Economists at the Paris-based Organization for Economic Cooperation and Development urged the Fed to "respond cautiously to developments until they can be interpreted with greater confidence." The OECD foresees growth of 3.5% in the U.S. this year and 2% growth next year. With inflation low, the Fed can wait for the economy to slow on its own, the OECD's top economist, Ignazio Visco, said Tuesday.
After cutting rates in November, the Fed adopted a directive saying that higher or lower rates were equally likely in the ensuing weeks. It maintained that stance in meeting in December, February and March. The last time the Fed ended a meeting with a directive tilted toward higher rates was in early July 1998.
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