Interest Rates on U.S. Agenda, Debt on World’s : Fed Faces Tough Debate on Whether an Increase is in Order

The Federal Reserve Board is scheduled to hold what analysts expect will be one of its more contentious meetings Tuesday to consider raising interest rates for the first time in roughly 1 1/2 years.

Arrayed on the one side: anti-inflation hawks, principally at the Fed’s regional banks, who argue that the central bank needs to increase rates to keep inflation in check.

On the other: the so-called doves, mostly political appointees on the Fed board in Washington, who question whether rates should be raised when the economy is slowing.

“There is a fundamental point of contention about how the economy’s working,” said James Annable, chief economist at First National Bank of Chicago. “It’s a debate about how fast the economy is growing and what it means to have an unemployment rate at 5.1%.”

A slim majority of economists polled by Reuters last week--17 of 30--believes that the central bank will opt to raise short-term rates Tuesday, with all but one of those analysts expecting a small increase of one-quarter percentage point.

Separately, the FBI has been called in to help the Fed investigate the source of a leak that eight of 12 Fed banks have recommended an increase in a key interest rate, according to sources familiar with the inquiry.

The Fed asked the Justice Department late last week for help in finding the source of the leak, sources said, and the FBI was assigned to the task. The decision to pursue an investigation with the help of the Justice Department is an indication of how seriously top Fed officials view the leak.

The request to involve the FBI also appears to confirm the accuracy of the leak, which came in the form of a Reuters report.

Fed spokesman Joseph R. Coyne declined to comment on any aspect of an investigation or even to confirm such an inquiry was in progress.

The decision to raise rates is fraught with political and economic risks for the central bank. A rate rise--even a small one--would lead to higher borrowing costs for consumers and corporations.

It would not be welcome on Wall Street or at the White House. Stock prices jumped to record levels on Wall Street last week, and a rate rise could dampen investor enthusiasm.

And President Clinton is counting on the maintenance of a trouble-free economy before the Nov. 5 election to help him win an additional four-year term.

Central bank officials admit that Tuesday’s decision will not be an easy one. “It’s a mixed bag,” said one official, who declined to be identified. “It’s more difficult than usual to pin down what’s happening” in the economy.

The economy, in the words of Fed Gov. Janet Yellen, is operating in an “inflationary danger zone.” But so far there is no sign of higher inflation.

At 5.1%, the unemployment rate is at its lowest point in more than seven years and at a level that in the past has usually led to stepped-up wage demands and higher inflation.

Wages, in fact, have already begun to pick up. But so far companies have been unable to pass those higher labor costs on to consumers in the form of price increases.

Firms have enjoyed fat profit margins for 5 1/2 years of economic expansion and thus have some leeway to absorb the higher labor costs. But it is not clear how long they can go without raising prices.

Much will depend of the course of the economy in the coming months, analysts said. On one hand, the economy seems strong. The jobs market is tight and companies are stepping up production and rebuilding inventories.

But there are also clear signs that growth is slowing. Retail sales have stagnated and the housing market has weakened, although it remains healthy.

Other factors are at play as well and analysts said it is hard to see how they will pan out.

If the Fed tightens credit because wages are rising, it risks giving ammunition to critics who see it as a pawn of Wall Street. If the Democrats then regain control of Congress, lawmakers may seize on the preelection rate rise as a reason to rein in the Fed, especially the regional banks.

But some of Clinton’s appointees to the Fed board may be sensitive to suspicions that they would favor the president and thus be more inclined to raise rates to prove their mettle to the markets and their colleagues.

“It’s a good bet there will be a pretty rigorous discussion around the table,” said Chris Varvares, an economist for St. Louis-based Macroeconomic Advisors.

Eight of the 12 regional Fed banks have called for a rate increase, and consensus-minded central bank Chairman Alan Greenspan may want to avoid a mutiny by them Tuesday.

In the end, the Fed’s decision may be more important symbolically than economically. A small rate rise would have only a minor impact on the economy and could easily be reversed later, analysts said.

But it would speak volumes about what the Fed’s priorities are, and that is why Wall Street and in Washington are watching so closely.