The Federal Reserve increased interest rates for the seventh time in a year Wednesday, sparking debate over whether the move will do more harm than good.
The Fed tightened both the discount rate and federal funds rate target by 0.5 percentage point, leaving the discount rate at 5.25 percent and the fed funds rate at 6 percent. Many major and regional banks, including some in the Northwest, responded by raising the prime interest rate for their best customers to 9 percent.
The increased cost of borrowing money should lower the risk of inflation by slowing consumer spending, which climbed last year to a record $904 billion.
But the cost of that restraint could be slower growth in the housing and auto industries, key elements of the economy, analysts said Wednesday.
Spokane and North Idaho could be particularly susceptible to a slowdown because of the prominent role housing has played in the region’s rapid economic expansion of recent years.
Home sales and construction slowed down in the last quarter of 1994. And January single-family home starts in Spokane County were off 64 percent from a year ago.
Local Realtors remain optimistic but concede that higher mortgage rates are beginning to hurt some people.
“I think the media and the TV folks hype this up quite a bit,” said Allen Plahn, a Realtor with John Beutler & Associates in Coeur d’Alene. “But what it does do is price a small number of buyers out of the market, and that’s a shame.”
The effect of any rate increase takes several months - some economists say at least a year - before it filters fully into the economy. Analysts say that’s why housing and auto sales have slowed only slightly nationwide.
Chris Marr, general manager of Foothills Lincoln Mercury and Mazda, said auto sales actually increased the last two months as buyers tried to beat the next rate increase.
“We saw a very large surge in December and January in anticipation of the hike,” said Marr, who is president of the Spokane County New Car Dealers Association.
“What a lot of people don’t typically realize, though, is that this interest rate hike had been anticipated for six to eight weeks, so the interest rate was already present from a financing point of view when they bought their car.”
As for the effect of higher rates on automobile prices, Marr said that’s a mixed bag.
Higher rates increase monthly payments. But Marr said many buyers don’t realize that interest rate increases also hurt dealers, who often borrow money to purchase cars to sell.
“And that makes dealers offer incentives and customer rebates to get more cars off the lot,” he said.
Nationally, the culmination of Fed rate increases, combined with the reduction of U.S. exports because of the Mexican financial crisis, will erode economic growth to an annual rate of nearer 3 percent than the 4 percent pace of 1994, analysts said.
“The actions of the Fed over the past year, the reactions of the bond market and now the (Mexican) peso crisis have shoved the U.S. economy toward much lower gear,” said Roger Brinner, chief economist at DRI/ McGraw-Hill.
Brinner predicted that there was a one-in-three chance that the economy might end up in a recession during the next two years.
Predictions like that have sparked debate between those who believe the central bank is deftly handling the economy, and those who fear the Fed has gone too far and now threatens to quash the nation’s robust recovery.
“1994 was a wonderful year in terms of growth and price stability,” said Federal Reserve senior economist Paul Ballew. “Our actions are intended to continue that and help continue the expansion.”
But on Tuesday, more than 20 House Democrats warned that higher rates could throw the country into a recession.
The economy appears to be in fine shape. The overall growth rate last year was a robust 4 percent, the best in 10 years.
But Federal Reserve Chairman Alan Greenspan worries that too robust an economy will ignite runaway inflation.
So far, that hasn’t happened. Inflation was a modest 2.2 percent last year, roughly half what it was in 1991.
“The question is not what was inflation,” said Ballew. “The question is what will inflation be? If you wait to act, you’re too late.
For savers and those on fixed incomes, the Fed’s actions have been eagerly awaited.
In the past year, one-year CD rates have risen from 2.9 percent to 5.2 percent. Money markets also have risen slightly, from 2.4 percent a year ago to 2.73 percent.
Investors, however, are telling a different tale. Rising interest rates are bad for stocks, and even worse for bonds Last year, on average, stocks rose only 1.3 percent. Bonds on average fell 3.5 percent.