September 30, 1997 in Nation/World

How Much Longer Can Rates Hold?

Associated Press
 

The economy seems to be settling into a more stable growth pattern. Most economists believe that will keep the Federal Reserve from raising interest rates right now. But how much longer?

The answer may depend on the groundwork laid in debate during central bank policy-makers’ closed-door meeting today.

With the expectation for no immediate rate change, stocks rallied Monday, pushing the Dow Jones average of industrial stocks up 69.25 points to 7,991.43, its highest close since Aug. 20.

As they look over the economy, Fed officials have got to be pretty pleased with what they see: plenty of growth and not much inflation.

“You have to go back to the early 1960s to see anything remotely similar,” said economist David Jones of Aubrey G. Lanston & Co. in New York. “‘So far, so good,’ is the Fed’s view.”

The economy grew very strongly in the first half of the year, at an annual rate of 4.1 percent, pushing the nation’s unemployment rate below 5 percent for the first time since 1973.

In the past, that’s been a harbinger of higher inflation, which can frazzle financial markets and short-circuit an expansion. The cure has been a preventative dose of higher interest rates aimed at moderating growth and keeping a lid on prices.

Yet policy-makers have little reason to bump up short-term interest rates, because inflation this year has improved, not worsened.

Consumer prices - excluding food and energy costs, which bounce around a lot - have risen at a scant 2.2 percent annual rate so far this year, down from 2.6 percent last year and the best since 1965.

“It’s been an incredible streak of luck,” said economist Paul Getman of Regional Financial Associates in West Chester, Pa. “I’m shocked. But if it lasts more than another six months, I’ll be doubly shocked. I really think by next spring the Fed will be back to raising rates.”

Jones said the move could come even sooner, at meetings scheduled for Nov. 12 or Dec. 16.

Just how soon he Fed moves depends on whether economic growth moderates enough the rest of this year to ease strain on factory capacity and the labor supply.

It also depends on a likely topic of debate at Tuesday’s meeting: the explanation for the good luck that has allowed the Fed to leave its benchmark rate on overnight loans between banks at 5.5 percent since March 25.

One argument, cautiously advanced by Fed Chairman Alan Greenspan, admits to the possibility the economy has entered a new era of increased productivity, driven by the rapid advance of technology in such fields at computing and telecommunications.

A long-run trend toward increased productivity, “new economy” proponents argue, is allowing corporations to pay both workers and stockholders more without raising prices faster than before.

Another school of thought, outlined in a speech two weeks ago by Fed board member Laurence H. Meyer, gives more weight to transitory forces holding down inflation. These include a strong dollar that has led to a decline in import prices, a slowdown in health insurance costs, a drop in oil prices and plummeting computer prices.

In the weeks ahead, any data showing that restraint on inflation is abating would settle the argument, at least temporarily, in favor of the second school and would be likely to trigger an interest-rate increase, analysts said.

“In a sense, this is an economy that’s sitting around waiting for something bad to happen. We know ultimately it will happen but we don’t know when and we don’t know to what degree,” said economist Robert Dederick of Northern Trust Co.

The last report available before the meeting, released by the Commerce Department on Monday, showed consumer spending moderating to a 0.3 percent advance in August.

© Copyright 1997 Associated Press. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.


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