Interest Costs Rise Further as Fed Hikes Discount Rate
The Federal Reserve, sending a strong public signal that the central bank is determined to continue its year-long trench warfare against inflation, boosted a key lending rate from 6.5% to 7% Friday.
The hike in the Fed’s discount rate to its highest level in almost three years, although widely expected, jolted Wall Street and helped spark another round of broad interest-rate hikes.
The Dow Jones industrial average fell 43.92 points to 2,245.54, and most banks immediately fell in line behind Chase Manhattan Bank, which lifted its prime lending rate Thursday from 11% to 11.5%. The interest rate hikes will be translated quickly into higher borrowing costs on a variety of consumer and business loans.
The Fed’s board of governors, citing “inflationary pressures in the economy,” approved the hike in the discount rate--the interest rate that the central bank charges financial institutions for emergency loans--on a 6-1 vote. Martha Seger was the lone opponent of the move.
The increase, the first since August, brought the discount rate to its highest level since April, 1986.
President Bush, speaking at a press conference in Tokyo before departing for Beijing, said of the Fed’s action: “I can’t say I’m happy about the rise in interest rates.” But he minimized his differences with Alan Greenspan, chairman of the Federal Reserve.
“I don’t think Greenspan and I are far apart,” Bush said. “We’ve got a little difference . . . on how you read the indicators on inflation . . . .”
He said that interest rates would decline once the White House and Congress reach agreement on a plan to reduce the U.S. budget deficit.
Bush has expressed concern that higher interest rates might choke off the U.S. economic expansion.
The increase came at the end of a week of steady rises in another key interest rate controlled by the Fed. The federal funds rate, which banks charge each other for overnight loans, rose from roughly 9.25% at the beginning of the week to close at 9.875% Friday.
The Fed fixes the federal funds rate, regarded as an even more significant measure of the central bank’s policy intentions than the discount rate, by controlling the supply of credit to the banking industry. The federal funds rate last was as high as 9.875% in October, 1984.
The boost in the discount rate followed closely on the heels of two recently released inflation reports, which showed that prices at both the wholesale and consumer levels jumped sharply in January.
It also came only a day after Treasury Secretary Nicholas F. Brady presented the most critical of a series of comments by Bush Administration officials over the last few weeks questioning the Fed’s policy of trying to curb higher inflation by gradually pushing interest rates up.
“I don’t see as strong evidence of inflation right now as does the Federal Reserve,” Brady told the House Banking, Finance and Urban Affairs Committee.
But there were signs Friday that the Bush Administration was having second thoughts about the wisdom of its verbal jawboning of Greenspan.
“Keeping inflation low is essential to sustaining the economic expansion . . . “ Brady said. “The Federal Reserve’s actions must be viewed in light of those goals.”
Another key member of Bush’s economic team, Richard G. Darman, director of the Office of Management and Budget, told reporters that public criticism of the Fed generally does the Administration more harm than good. It is “extremely unhelpful,” he said, “to have overt, visible disagreement (between) key economic policy makers of an Administration and the chairman of the Fed.”
Darman acknowledged the Administration is worried that if higher interest rates “continue over a period of time, it would have seriously adverse consequences” on its hopes for sustained economic growth.
Seeks Budget Bargaining
Attempting to prod Democrats on Capitol Hill to launch behind-the-scenes bargaining with the White House on the budget, he said that the recent rise in interest rates should give both Congress and the White House “all the more reason for negotiating (a deficit reduction agreement) on some basis that isn’t business as usual.”
Michael J. Boskin, the White House’s chief economic adviser, said that he supports the Federal Reserve in its goal of trying “to keep inflation low and prevent it from rising.”
The discount rate move also appears to have deflected a potential rift between a group of Fed regional bank presidents, who frequently have pushed for tougher actions against inflation, and the Washington-based board of governors, some of whom had thought inflation fears were exaggerated.
The discount rate is set by the board, while actions that affect the fed funds rate are determined at meetings attended by all of the Fed’s top officials.
Wayne Angell, a Fed governor, insisted that “it is way too simplistic to talk just about a dichotomy between the (regional bank) presidents and the board.” But he added that “some of us here are very well aware that monetary policy in the past has often led to stop-go policies, and we have a large incentive to avoid those kinds of disruptions.”
And some signs of tension inside the Fed remained. The central bank said that two of the 12 regional Federal Reserve banks--Cleveland and Dallas--did not join in the request for a 7% discount rate, and it appeared that those banks would have preferred an even sharper increase in the discount rate.
The discount rate was last at 7% from March 7 to April 18, 1986, when it dropped to 6.5%. The rate bottomed at 5.5% in August, 1986.
Analysts were sharply divided over the impact of the Fed’s action.
Some said that they believe the central bank’s discount rate hike does not go far enough to stem inflationary pressures. “The Fed was too little, too late,” said A. Gary Shilling, a New York economic consultant.
Against Tightening
But other economists said that they are just as convinced that the Fed should avoid any further credit tightening. They argued that recent signs of escalating inflation will soon dissolve and that the Fed is unnecessarily running the risk of pushing the economy into a recession.
“The Fed is moving the economy into an unknown danger zone,” warned Richard Rahn, chief economist at the U.S. Chamber of Commerce. “They are overreacting to nothing more than an inflationary blip we’re in and already have gone far enough that there’s a good chance we’ll move into a low-growth posture.”
Most analysts, however, agreed with Shilling that the Fed’s action is necessary to prevent the economy from overheating and help keep inflation from escalating.
“If the Fed waited too long to confront the growing inflation problem, you could blow this economy out of the water,” said Lyle Gramley, a former Fed governor who is chief economist at the Mortgage Bankers Assn. “The economy is still too robust for its own good.”
John Makin, a top economist at the American Enterprise Institute here, agreed that the Fed “is moving in the right direction. If they hadn’t tightened, interest rates would have gone up anyway and the Fed would be further behind the curve.”
He acknowledged, though, that signs of higher inflation increase the odds of a recession later this year or next year. “They may be doing the best they can,” he said, “but there are no guarantees the Fed won’t make a mistake.”
