Central Bank Leaves Rates Unchanged
Despite growing signs that the U.S. economy is churning ahead faster than most forecasters expected, Federal Reserve Board officials Wednesday held off on hiking interest rates for the time being.
The decision was widely expected, but it does not alter views that the Fed may push up rates later this year to prevent an outbreak of inflation.
“The Fed should tighten. They are going to tighten,” said David Wyss, an economist at DRI-McGraw Hill in Lexington, Mass. “But when they will tighten is not yet clear.”
News of the decision, made at the end of a two-day session of the Fed’s policy-setting Open Market Committee, spread quickly in the early afternoon, comforting Wall Street, where stocks had fallen sharply. The Dow Jones industrial average closed down 17.36 points after having fallen nearly 38.
The closed-door meeting was the first to be attended by two newcomers to the Fed board of governors: Alice Rivlin, the former White House budget director, and Laurence H. Meyer, an economic forecaster from St. Louis. Neither is expected to tilt the Fed away from its anti-inflation stance.
Many forecasters have been expecting the U.S. economy to slow somewhat in coming months because of the fallout from a rise in long-term interest rates earlier this year, consumer debt levels and other factors. In recent weeks, however, many of the hints have suggested faster growth instead, raising expectations that the Fed will push up interest rates to ensure that inflation does not emerge as a problem.
On Wednesday, the Commerce Department reported that factory orders shot up 1.9% in May, the biggest increase in nine months. That report came just a day after news that new-home sales for May rocketed to the highest level in a decade and the index of leading economic indicators--a forecasting gauge--reached the highest level since early last year.
“New-home sales were very strong, and that is the area that was supposed to have weakened” because of higher mortgage rates, said Edward Yardeni, chief economist with the Deutsche Morgan Grenfell/C.J. Lawrence investment firm in New York.
This varied set of indicators has convinced some observers that the economy is warming up considerably and that the danger of rising prices now outweighs the danger of an imminent recession.
The core rate of inflation, a measure that omits volatile food and energy costs, has crept up a few tenths of a percentage point from a year ago, an amount too small to set off alarm bells but large enough to register on economists’ radar screens.
“It’s a debate,” said Yardeni of the issue of how much growth is possible without unleashing inflation. “We’re not 100% certain that strong growth is necessarily inflationary.”
Not every recent sign has pointed to faster growth. On Wednesday, for instance, the U.S. Chamber of Commerce released a monthly index of business confidence, which fell in June, signaling a possible slowdown in growth, employment and sales.
The drop “is consistent with expectations that the economy will slow somewhat in the second half of the year,” said Martin Regalia, chief economist of the chamber. “But there is no indication that the slowdown will be severe.”
Beyond the question of economic growth rates and inflation, some Fed watchers wonder whether officials will resist hiking interest rates to avoid even the appearance of meddling in the presidential election. But others warn that such political sensitivities can easily be exaggerated.
For example, the Fed pushed up interest rates half a percentage point in 1984, a move to slow the economy that did not prevent the reelection of incumbent Ronald Reagan. The Fed eased rates by half a point in 1992, a move to stimulate the economy that did not prevent the defeat of incumbent George Bush.
And those actions were minor compared with some: Back in 1980, the Fed hiked interest rates twice and eased them three times, Yardeni said.
“The track record shows that they’ve tightened, they’ve eased and they’ve done nothing in an election year,” he said.
But Wyss, the economist at DRI-McGraw Hill, cautioned that political realities should not be dismissed in considering how the Fed may act this year. President Clinton recently nominated Alan Greenspan, a lifelong Republican, to serve a third term as board chairman.
“It’s not impossible to tighten in an election year, but you need some pretty convincing evidence to do it,” Wyss said. “Political realities are realities, especially if you live inside the Beltway, as the [Federal Reserve] board does.”
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Factory Orders
Total new orders in billions of dollars seasonally adjusted
May: $315.9
Source: Commerce Department
