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Higher Rates May Finally Cool Economy

One year after the Federal Reserve embarked on its journey toward slower growth by raising interest rates, there are few signs that the U.S. economy is shifting into a lower gear.

Wall Street economists generally agree that aside from scattered signs of a downshift in residential construction, auto sales and money growth, the economy continues to motor along at a healthy speed.

But that doesn’t mean slower growth isn’t lurking around the curve, they say. Economists of just about every stripe think the higher rates will begin to take their toll on an economy that created more jobs in 1994 than it had in any year of the past decade. The belief is that the Fed’s seven interest rate increases in the past 12 months will slow economic growth exponentially in 1995.

“The underpinnings of the economy look strong and it’s surprising how little effect rate hikes have had,” said Lyle Gramley, who served on the Federal Reserve Board of Governors from 1980 until 1985. But Gramley, now a consulting economist at the Mortgage Bankers Association, sees scattered evidence that interest-rate-sensitive sectors of the economy are feeling the strain.

Since Feb. 4, 1994, the Fed has doubled the federal funds rate from 3 percent to 6 percent.

Fed officials and Wall Street analysts generally agree it takes about a year before the economy reacts to a change in rates.

Indeed, in a statement accompanying the seventh increase, a one-half point uptick on Wednesday, Fed officials said there were merely “tentative signs of some moderation” in the economy. Moreover, economic activity has continued to advance at a substantial pace, the Fed said.

The expected slowdown in the economy wasn’t very evident in the fourth quarter of 1994. The Commerce Department reported gross domestic product rose at an annual rate of 4.5 percent in the final three months of last year. That strong performance helped push growth for the entire year to 4 percent, the economy’s best showing since 1984.

The housing market is one place, though, where the higher rates can be felt already.

“The housing sector of the economy defied the laws of gravity in 1994, but now it’s coming down to earth,” said Scott Grannis, director of economics at Western Asset Management Co.

The Commerce Department reported sales of new single-family houses fell 0.6 percent in December, after a 9.6 percent decline in November. That two-month contraction was coupled with three straight months of declines in housing starts, leaving many analysts convinced the housing sector is losing momentum.

Perhaps the clearest indication is in residential construction, which fell 6 percent in the third quarter of 1994 and 2.6 percent in the fourth quarter, said Michael England, chief economist at MMS International.

The automobile sector of the economy also has displayed some signs of moderation, say analysts, who expect the industry to peak in 1995 as higher interest rates, rising car prices and slackening demand combine to reduce sales.

Tags: business

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