Fed Raises Discount Rate to Fight Inflation; Prime Goes Up Half Point

The Federal Reserve, signaling a tough stance against inflation under new Chairman Alan Greenspan, announced today that it is increasing a key lending rate for the first time in three years. The move immediately triggered an increase by major banks in their prime lending rate.

The Fed increased its discount rate, the interest it charges on loans to U.S. financial institutions, from 5.5% to 6%.

Within minutes of the announcement, major banks across the country said they were raising their prime lending rate by half a percentage point to 8.75%, the highest level for the prime rate since March, 1986.

In a brief statement, the Fed said its decision “reflects the intent of the Federal Reserve to deal effectively and in a timely way with potential inflationary pressures.”

Move Draws Support

The Reagan Administration, which at times in the past was critical of tightening moves made by former Fed Chairman Paul Volcker, supported today’s discount rate increase.

“The Administration concurs with the action of the Federal Reserve in raising the discount rate in order to deal with potential inflationary pressures,” the Administration said in a statement read by a Treasury Department spokesman.

Allen Sinai, chief economist of Shearson Lehman Bros. of New York, said he believed the Fed decision was taken in an effort to cool inflationary forces stemming from the recent declines in the value of the dollar.

Inflationary Pressure

“Anything that helps the dollar helps inflation because the weak dollar is the chief inflationary pressure we have right now,” he said.

The action was the first significant move the central bank has made since Greenspan replaced Volcker as chairman Aug. 11.

The last increase in the discount rate, boosting it from 8.5% to 9%, was announced on April 6, 1984, and took effect three days later. Since then, the rate has been cut seven successive times, with the last reduction occurring a year ago, on Aug. 20, 1986, when it dropped from 6% to 5.5%.

The discount rate announcement by the Fed was followed almost immediately by announcements from two large New York banks, Chase Manhattan and Chemical Bank, that they were raising their prime business lending rates half a percentage point to 8.75%.

Other Banks Follow

Later in the day, other major banks across the country joined the rush to increase their prime rate. Among them were the nation’s largest bank, Citibank, First National Bank of Chicago, Mellon Bank of Pittsburgh and Manufacturers Hanover.

An increase in the discount rate is the most dramatic move the central bank can make to signal its intentions to push rates higher as a way of keeping a curb on inflationary pressures in the economy.

One of the major forces that has been pushing up prices this year has been the falling dollar, which boosts the cost Americans must pay for foreign products.

The Reagan Administration, beginning in September, 1985, pursued a policy of pushing the dollar lower as a way of reducing the huge U.S. foreign trade deficits. Administration officials hoped that higher costs for imports would reduce Americans’ appetite for foreign products, while at the same time making U.S. products more competitive on overseas markets.

While this strategy appears to be working, the turnaround took much longer than expected and has a downside of increasing inflationary pressures in the United States.