Fed Boosts Rate Amid Worries of Labor Shortage
The Federal Reserve raised a key short-term interest rate to 5.5% on Tuesday, warning that the booming U.S. economy continues to strain against its limits and that employers are running out of people to hire.
It was the third time this year that the Fed boosted the federal funds rate, which banks charge one another, by a quarter-point in hopes of protecting against an outbreak of inflation.
To drive home its concern, the central bank also raised the largely symbolic discount rate, which the Fed itself charges for short-term loans, by a quarter-point to 5%.
Fed policymakers looked past new evidence that the economy is operating with growing efficiency and little inflation. They concentrated instead on the nation’s tightening labor markets.
“The pool of available workers willing to take jobs has been drawn down . . . in recent months, a trend that must eventually be contained if inflationary imbalances are to remain in check,” the Fed said in a news release.
Wayne M. Ayers, chief economist of Fleet Boston Financial, offered this interpretation: “They’re worried the labor market is flashing amber, and they want to do something about it.”
Financial markets did not seem to share the Fed’s worries. After driving down prices in the minutes after the Fed’s announcement, investors sent them right back up. The Dow Jones industrial average closed up 171.58 points, or 1.6%. Both the Standard & Poor’s 500 index and the Nasdaq composite index hit new highs.
Normally, stock prices fall when the Fed raises interest rates and, with them, business costs. Analysts said the market’s unusual jump reflected investors’ conviction that the central bank would not act again until well into next year, in part because of uncertainty surrounding the Y2K computer problem.
“They can’t act in December because of Y2K and they won’t have much additional information by the February meeting, so that means March,” said Lyle Gramley, a former Fed member who now consults for the Mortgage Bankers Assn. in Washington.
The Fed accompanied Tuesday’s rate hikes with a shift in its policy outlook from a bias for raising rates to neutral, a signal the central bank is as likely to cut rates as raise them in the near future.
Some observers interpreted the bias shift as more evidence that the Fed would not act soon, although veteran observers of the central bank said the move is purely procedural. The Fed also adopted a neutral stance after each of its rate hikes this year on June 30 and Aug. 24.
For average Americans, the immediate effects of the Fed action are likely to be slight.
Wells Fargo & Co. and other commercial banks immediately raised the prime lending rate, which they charge their best corporate customers, by a quarter-point, to 8.5%. In addition, the market interest rate on a 30-year U.S. Treasury bond rose slightly, to 6.06%.
But rates that most affect consumers, such as those on a 30-year mortgage, had already risen in reaction to previous Fed rate hikes and in anticipation of the latest one.
Since mid-May, when the Fed first said that it was leaning in favor of tightening, rates on an average 30-year mortgage have climbed more than a half a point, to 7.67% last week.
Separate from its rate hikes Tuesday, the Fed released figures showing that U.S. industrial production climbed at its fastest pace in seven months in October. Output at the nation’s factories, utilities and mines climbed 0.7%, after falling 0.1% in September, largely as a result of Hurricane Floyd’s impact on the East Coast.
The new figures are the latest to depict the economy as continuing to grow despite the Fed’s previous rate hikes and some signs of slowdown in interest-rate-sensitive sectors such as housing. In recent weeks, the government has also reported that the gross domestic product expanded at a snappy 4.8% annual clip from July through September and that the unemployment rate fell to 4.1% in October, its lowest level since January 1970.
In the past, such numbers would have been more than enough to convince the Fed to raise rates in order to protect against inflation. But this time around, they have been accompanied by almost as spectacular growth in productivity--output per worker--a development that has allowed businesses to hold the line on prices even as they pay higher wages. The result: Inflation has remained largely in check, so far.
In such circumstances, Fed policymakers have been forced to rely on their instincts about how much more the economy can grow before it encounters limits. They appeared to acknowledge as much in announcing the rate hikes: “Although cost pressures appear generally contained, risks to sustainable growth persist.”
“They think the risk of inflation rising is greater than the risk of it falling,” said Mickey D. Levy, chief economist with Bank of America in New York.
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