Odds Improve That Fed Will Increase Rates Clear Signs Of Economic Strength Sure To Spook Federal Reserve Board, Official Believes

The likelihood that the Federal Reserve will increase interest rates has jumped dramatically following a steep decline in the unemployment rate, in the view of many top economists.

That position was bolstered by comments from Fed Governor Laurence Meyer, who pointed to Friday’s unemployment report and various other statistics that showed the economy has developed “considerable momentum.”

“We are in a circumstance in which a prudent central bank must exercise heightened surveillance of the inflationary risks and stand ready to respond if necessary,” Meyer told the National Association of Business Economists in Boston on Sunday night.

Meanwhile, a prominent group of economists known as the Shadow Open Market Committee that closely monitors Fed policy said Monday that the Fed should move to tighten credit conditions. The members said the action was likely to occur at the central bank’s next meeting in two weeks.

“We believe it is appropriate now to take a slight pre-emptive tightening action,” said Allan Meltzer, head of the group and a professor at Carnegie Mellon University.

The stock market handled the news well Monday as the Dow Jones industrial average jumped back near record levels. Last month, fears of rate increases to cool a strengthening economy caused the market to plummet.

The Dow industrials rose 73.98 to 5,733.84, moving within 50 points, or less than 1 percent, of the all-time high at 5,778.00, set May 22. Analysts said the move was part of a broad advance amid mounting optimism that inflation and interest rates aren’t poised to soar.

But many private economists said Monday they believed central bank policymakers themselves were preparing financial markets for a rate increase, the first such move since February 1995.

In addition to Meyer’s remarks, they said a number of Fed governors and regional bank presidents who serve on the 12-member Federal Open Market Committee, the group that sets interest rate policy, have spoken about the need for increased vigilance given the economy’s surprising strength in recent months.

Fed Chairman Alan Greenspan, delivering the Fed’s midyear economic report to Congress in July, pledged that the central bank would move quickly to increase interest rates “should the weight of incoming evidence persuasively suggest an oncoming intensification of inflation pressures.”

While Fed officials passed up opportunities to raise interest rates at their July and August meetings, believing the economy was beginning to slow, a string of reports since then have called that view into question. Factory orders and housing sales took unexpectedly big jumps in recent reports and then Friday’s report showed unemployment dropping in August to its lowest level in seven years, 5.1 percent, down from 5.4 percent in July.

“I think the unemployment report is the straw that breaks the camel’s back,” said David Jones, an economist at Aubrey G. Lanston & Co. in New York. “We have reached the point where we are likely to see accelerating wage and price pressures and that is what Meyer was hitting at in his remarks.”