Fed Nudges Up Interest Rates in Effort to Slow Down Economy
The Federal Reserve, after meeting this week to discuss monetary policy goals for the year ahead, modestly pushed up short-term interest rates Thursday in a move aimed at slowing economic growth and curbing inflationary pressures, traders said.
The action, which appears aimed at boosting the key federal funds rate that banks charge each other for overnight loans from roughly 8.5% to about 8.75%, followed on the heels of a similar monetary tightening in West Germany and helped to shore up the dollar despite the German move and the somewhat disappointing U.S. trade figures released Wednesday.
Reading the Fed’s tea leaves is always a difficult task, but analysts expressed widespread agreement that the central bankers had decided to push interest rates higher. “By not adding reserves (to the banking system) today, the Fed has made it clear it intends to tighten,” said James Capra, a bond market analyst with the investment firm of Shearson Lehman Hutton in New York. “The only question is how much.”
Expect Some Softening
The Fed, following its usual practice, does not comment on market moves by its trading desk in New York. The Fed closely influences short-term interest rates by buying and selling government securities on the open market.
In trading Thursday, the federal funds rate ranged between 8.625% and 9%, closing at 9% for the day. But analysts said they expected the rate to soften in the days ahead from its highs Thursday because of a number of technical factors.
Most analysts believe that the Fed will follow up its move with further interest rate hikes early next year, and they generally expect the central bank to boost its closely watched discount rate from the current level of 6.5% sometime before President-elect George Bush takes office in late January.
But economists are deeply divided over whether the Fed’s tightening actions will be enough to cool off the nation’s still-steamy economy, with many analysts expecting even more robust growth early next year and just as many others seemingly convinced that higher interest rates will produce a sharp slowdown in the economy in 1989.
“The economic data show upward momentum, so the first half of 1989 should be quite strong,” said David M. Jones, a Fed watcher at the Aubrey G. Lanston & Co. investment firm in New York. “As a result, this is bound to be the first of a series of tightening moves by the Fed continuing early next year.”
And John Silvia, an economist for Kemper Financial Services in Chicago, said the Fed’s modest tightening is “consistent with its gradualist, cautious approach under (Fed Chairman Alan) Greenspan. In fact, I think they have been erring on the side of too much caution.”
But Jerry Jordan, chief economist at First Interstate Bank in Los Angeles, while agreeing that interest rates are likely to continue to move higher next month, said he believes that rates should peak relatively early in 1989 because the Fed’s squeezing of the money supply is likely to produce a relatively mild recession sometime next year.
For the moment, both international and domestic pressures are prodding the Fed in the same direction toward higher interest rates.
Growing Too Fast
“The Germans, in effect, forced (the Fed’s) hand,” Jordan said. “With the Bundesbank (West Germany’s central bank) tightening and the apparent domestic strength in the U.S. economy, I don’t see that they had much choice.”
In their meeting Tuesday and Wednesday, members of the Fed’s Open Market Committee apparently concluded that the economy is growing too fast for its own good, generating fears of higher inflation. The government reported earlier this month that more than 460,000 people were hired in November, a huge jump in employment that convinced many analysts that the economy has been gaining speed.
A robust expansion has been under way throughout 1988 despite a number of tightening moves by the Fed earlier this year that have pushed up short-term interest rates nearly two full percentage points since early spring.
“From my perspective as a central banker, a slowing trend actually would be desirable,” Robert T. Parry, president of the San Francisco Federal Reserve Bank and a member of the Fed committee, said last week.
“The economy can’t afford to grow faster than the rate of growth in our long-run capability to produce goods and services,” he said. “This means the economy should expand next year (and over the next several years) at less than a 2.5% pace. The economy’s structural imbalances may tend to push us higher than that, but the Fed must resist these pressures.”
