Let’s Hope He’s Right : Fed raises short-term rates; markets plunge

Does it make sense to raise short-term interest rates in order to keep other interest rates from rising? Yes, according to Federal Reserve officials. Let’s hope they’re right.

In an unusual move, the Fed made a pointed public announcement Friday that it is tightening credit by raising a key short-term rate for the first time in five years. The goal is to check inflation with a preemptive strike, maintain stability in long-term interest rates and sustain the economic recovery.

Will the Fed’s stunning departure from its usual nebulous, go-slow approach to fighting inflation succeed? The timing, speed and bold announcement of the increase certainly surprised the financial markets. The Dow plummeted nearly 100 points Friday.

The announcement occurred within a week after Fed Chairman Alan Greenspan first signaled that short-term rates would rise soon, and the day after the typically secretive Fed Open Market Committee voted to nudge one rate a tiny bit. The increase--a federal funds rate hike on overnight loans of 0.25%, to 3.25%--will prove tolerable if it cools inflation worries that could drive up long-term borrowing costs for consumers, business and governments.

Affordable mortgages are crucial to a housing recovery in California. For six months home sales have been rising nicely, thanks to both low rates and a bottoming in housing prices. Keeping that recovery cooking is vital, especially now that the Northridge earthquake is further dampening housing prices.

The Fed’s seven-member board has long been dominated by anti-inflation hawks. Two such members are resigning, giving President Clinton an opportunity to fill the posts. If the appointments tilt the board toward a less attentive inflation-fighting policy, that too could drive up long-term rates. The President’s appointments will be closely watched.