Inflation-Worried Fed Pressured to Stem Dollar’s Rise

The Federal Reserve Board is coming under increased pressure to reduce interest rates, even though some board members continue to fear that the U.S. economy is still growing too robustly to abandon concerns about inflation.

The pressure comes from U.S. trading partners and from the Bush Administration. Both want U.S. interest rates lowered to help stem the rise in the value of the dollar, which is threatening to stymie further reduction of the big U.S. trade deficit.

Trade Date Cited

President Bush and Treasury Secretary Nicholas F. Brady both have said they are concerned about the dollar’s rise. Brady told a meeting of the 24-nation Organization for Economic Cooperation and Development here last week that a continued rise in the value of the greenback will jeopardize the progress in reducing the trade deficit that the United States has made over the last 2 1/2 years.

The White House is also concerned that, if interest rates remain high for too long, the economy could be sent into a slump, dealing a blow to White House efforts to keep the federal budget deficit from increasing.

Top Administration policy-makers believe the economy already has begun to slow sufficiently to relieve any inflationary pressures from last winter’s sudden price surge. They fear that higher interest rates will exacerbate inflation.

Fed Split on Interest Rates

But the Fed is not as worried about the dollar’s rise, and it still is split over whether to nudge interest rates down.

Although opposition to reducing interest rates has begun to erode within the policy-setting Federal Open Market Committee, a telephone poll of members of that panel last week failed to produce a consensus on any new action.

The central bank is expected to consider the issue again on Monday or Tuesday, before Fed Chairman Alan Greenspan goes to a conference with bankers in Madrid.

There is little question that reducing interest rates in the United States--while they simultaneously go up in West Germany and Japan--would blunt the dollar’s rise. Part of the reason the greenback keeps edging up is that interest rates in the United States are higher than usual in relation to those in its two major economic allies, prompting currency traders to flock to the dollar.

Allies Face Inflation

Political uncertainty in West Germany and Japan also is contributing to the dollar’s rise. So is growing inflation in those countries. And political turmoil in places like Argentina and China is strengthening the dollar’s value as well.

The difficulty is that the Big Three economic powers are split over how to handle the situation.

West Germany and Japan, alarmed by the resurgence of inflation in their countries, are moving toward more restrictive economic policies. Japan raised its discount rate--the interest charged on short-term loans to commercial banks--last Tuesday. West Germany’s Bundesbank has not moved yet, but it, like the Fed, is under increasing pressure every day.

But the Bush Administration wants the Fed to take on most of the burden by reducing interest rates at home because it fears that interest-rate increases abroad might create recession in those countries, which could cause foreigners to buy fewer U.S. imports and hamper further progress in reducing the U.S. trade deficit.

Inflation Worries Continue

Administration officials have been making their views plain to Fed governors. But the Fed itself is divided: Some of the Fed’s seven Washington-based governors are willing to consider a small reduction in interest rates, but the presidents of the system’s regional banks--who also sit on the Federal Open Market Committee--believe inflation pressures in the United States still are too strong to discount.

So far, the Administration has been relatively restrained in its exhortations. The view among Treasury officials is that the sooner interest rates are reduced the better--for the dollar and for the domestic economy. The Treasury, convinced that the economy has begun to slow and that inflation pressures will abate, is far less concerned than the Fed about the threat of spiraling prices.

How long the Fed can hold out is unclear. The dollar edged down slightly on Friday, but its overall rise has sent traders rushing to bid prices still higher, overwhelming the so-far sporadic efforts of the Big Three central banks to intervene in the exchange markets to curb the dollar’s rise.

Coordination Discounted

Adding to the sense of urgency is the growing view in the foreign exchange markets that the long-touted policy coordination efforts of the United States and its economic allies are rapidly unraveling. If the Fed does not act soon, the dollar could keep rising higher and higher.

In the end, many analysts believe, the Fed will act--or, just as possibly, put off any action--mainly for domestic reasons. There is little concern within the Federal Open Market Committee about the consequences of the rising dollar, and unless there is a run on the greenback--the opposite of the current problem--Fed officials are likely to let the markets have their way.

These analysts say that, if the Administration prevails on the central bank to reduce interest rates for the sake of keeping the dollar’s value down, the Fed will be acting more for public relations reasons than out of genuine concern about the trade deficit. That means any action that comes soon is likely to be small.