Fed Hikes Interest Rates; Increase Is Biggest of the Year : Economy: Boost of three-quarters of a point in funds rate and discount rate reaffirms central bank’s fight on inflation. Critics see dangers to growth and job creation.
The Federal Reserve Board signaled its commitment Tuesday to quash any evidence of inflation by raising its two benchmark interest rates by three-quarters of a percentage point each, marking the central bank’s sixth and largest increase of the year.
The Federal Reserve took the aggressive move in the face of mounting criticism that it has already gone too far this year to restrain economic growth and job creation to curb the potential threat of rising prices. The action to raise rates was the first since August.
The seven-member Federal Reserve board of governors voted unanimously to raise the bank’s discount rate--the rate it charges commercial banks--from 4% to 4.75%. In a separate meeting, the Fed’s open market committee voted to increase the more influential federal funds rate, the interest that banks charge each other on overnight loans, by three-quarters of a point as well, to 5.5%. The Fed’s actions were quickly followed by increases of three-quarters of a point by commercial banks in their prime rates to 8.5%--increasing borrowing costs for millions of Americans with variable rate loans tied to the prime.
Tuesday’s Federal Reserve action seemed to be a departure from Chairman Alan Greenspan’s strategy of gradualism in setting interest rate policy and suggested that he and senior officials of the central bank now believe that the economy is growing at a stronger pace than they had anticipated.
The five previous rate increases this year were either quarter-point or half-point moves. The decision Tuesday for larger increases appears to be an acknowledgment that Federal Reserve officials had underestimated the strength of the economy.
Even though Greenspan and other central bank officials acknowledge that there are few signs of rising prices, they believe that it is crucial for them to take preemptive action against inflation. Greenspan has argued that monetary policy acts with a long lag time and that, if the Federal Reserve waits to strike until inflation is evident in the economy, it will be too late to stabilize prices. Suddenly raising rates at that point could disrupt economic activity.
The nation’s inflation rate stands at 2.7% for the first nine months of the year, with the consumer price index for September up two-tenths of a point, the last month for which figures are available. The index rose by three-tenths of a percentage point in each of the three previous months.
The Federal Reserve’s decision to get ahead of what it sees as “the inflationary curve” pleased some economists. “It was appropriate--in fact it was overdue,” said Cynthia Latta, an economist at DRI-McGraw Hill, an economic consulting firm based in Lexington, Mass. “I think the Fed has had trouble keeping up with economic growth--each month we seem to see higher forecasts--and so the Fed decided to get ahead of it for once.”
“It’s a good move. It cleared the air of a lot of uncertainty in the markets about how far and how fast the Fed would go,” added economist Scott Pardee, chairman of Yamaichi International (America) Inc.
Others, however, expressed criticism of the action.
“Continuing this policy of raising interest rates not only endangers the economic expansion but it hurts working men and women who have not seen their wages keep up with the expanding economy,” said House Budget Committee Chairman Martin Olav Sabo (D-Minn.).
And, while most of the criticism came from Democrats and liberal groups, some business leaders and Republicans also expressed growing concern about what they view as overly aggressive Federal Reserve policies. Jerry Jasinowski, an economist and president of the National Assn. of Manufacturers, said that Tuesday’s action “was not necessary. While the economy grew faster than expected in the third quarter, there is not much evidence of inflation. The Fed is fundamentally misreading the American economy.”
In addition, Sen. Alfonse M. D’Amato (R-N.Y.), who is expected to become the next chairman of the Senate Banking, Housing and Urban Development Committee, which has oversight responsibilities for the central bank, declared that “inflation is practically nonexistent.” He said that the Federal Reserve has “acted cautiously to assure that it does not become a problem,” but said he hopes “these actions today will not contribute to weakening economic prospects.”
Since Feb. 4, the central bank has increased the federal funds rate--which is widely considered to be the Federal Reserve’s most important monetary policy tool--by 2.50 percentage points. Economists said that in the past federal funds rate increases of two to three percentage points have been enough to slow the U.S. economy and anything above that level has pushed the country into a recession.
Most economists are now betting that the Federal Reserve has moved far enough to avoid the threat of rising prices next year but not so far that its policies will lead to a recession. Economists generally expect the economy to undergo a sharp slowdown next year because of the central bank actions, reducing overall economic growth to below 2.5% from this year’s pace of about 3.9%.
But many Federal Reserve officials and conservative economists believe that economic growth cannot be sustained above 2.5% without risking higher inflation and so are committed to that growth rate as a key target for monetary policy.
The rate decision came on a day when the government reported that retail sales jumped by an unexpectedly strong 1.1% in October and U.S. industry operated at 84.9% of capacity last month, the highest level in nearly 15 years.
Tuesday’s strong action has convinced many economists that the central bank has finally caught up with the pace of economic growth and will not raise rates again in its next major policy meeting in December. Many observers think that it may be able to put off another rate hike until February or even later.
“It’s a pretty large move and they clearly wanted to make a statement that they are here, they are in charge and that they will take care of inflation,” observed Donald Ratajczak, an economist at Georgia State University.
But that enthusiasm for the Federal Reserve strategy was not shared by the central bank’s widening circle of critics, ranging from leading business executives to unemployed workers and lawmakers--who argued that the central bank’s focus on price stability is choking off the nation’s recovery as it is beginning to generate more jobs and higher wages.
Hundreds of unemployed workers and other protesters demonstrated outside the central bank’s Washington headquarters, chanting for Greenspan to change his mind and hold down rates.
“We came here to tell them to stop raising rates. It’s making the job outlook very gloomy,” said Lester Thomas, a 54-year-old unemployed sheet metal worker from Philadelphia, as he protested outside the Fed headquarters.
Tracking the Increases
The Fed’s policy-making panel raised short-term interest rates for the sixth time this year. In its statement, the Fed sought to signal its resolve to fight any reappearance of inflation.
1994 Federal Funds Increases: The federal funds rate is what banks charge each other on overnight loans:
Nov. 15: 5.50%
1994 Discount Rate Increases: The discount rate is the interest the Fed charges to make direct loans to banks.
Nov. 15: 4.75%
30-Year Fixed Home Mortgage Rates
Nov.: 9.22%
