Will Fed Lower Boom on Booming Economy?

This month, the once unthinkable becomes official: America’s economic boom will smash the all-time record for longevity, replacing the 1960s as the most durable streak of prosperity in U.S. history.

But can the good times keep on rolling if interest rates keep on rising--as they are expected to do again as soon as Wednesday?

Jeremy Breck, a systems analyst, isn’t going to get in the way. “If I were in the market for a house or car, a few points might make a difference,” Breck, 34, said on a recent visit to Seattle’s upscale Pacific Place mall. “But probably not a quarter point or so.”

This historic expansion, which began in the spring of 1991 and today enters an unprecedented 107th month, has been distinctive for more than just its duration. Mostly it has been a private-sector triumph marked by a burst of information technology, relentless cost-cutting by business and the globalization of markets.

The government has contributed largely by staying out of the way. When it has intervened, it has generally been through fine-tuning of interest rates by the Federal Reserve: up a little when inflation threatened, down a little when growth seemed imperiled.

With growth accelerating, the Fed hiked rates by one-quarter of a point three times last year and is widely expected to order a fourth increase at the end of a two-day meeting that begins today. The Fed’s key short-term rate is now 5.5%.

Increasingly, however, experts doubt that modest rate shifts by the Fed will have any more effect on gleeful consumers and businesses than last year’s did.

The economy boomed along at a boisterous annual growth rate of 5.8% in the final three months of last year, and consumer sentiment floated up to the highest level since it was first measured 32 years ago. On Monday, the Commerce Department reported that consumers closed out last year with a red-hot burst of spending that substantially outpaced their gains in income.

Consequently, some believe that the Fed will have to use a heavier hand to choke off inflation in coming months.

“It really is time to put away the tuning fork and take out the hammer,” said Joel L. Naroff, an economic consultant near Philadelphia. He predicted that a “timid” quarter-point hike this week could be the prelude to a half-point boost in March.

“If any members of the [Fed] think that consumption is going to tank soon, they can forget it,” he said.

Diane Swonk, economist and senior vice president with Bank One Corp. in Chicago, said unemployment is so low and wages are rising so fast that they overshadow any tinkering with interest rates. To consumers, she said, “this is an economy that feels really good.”

It feels good to Will Huff. Gazing at a sea of big-screen televisions in a Glendale electronics store, he was considering his own plans to buy one for about $4,500 later this year, along with a digital disc player.

Huff, 33, a “tech guy” originally from Ohio, was aware that interest rates have been creeping upward but was not overly concerned because he doesn’t carry much debt. “For me, the interest rate is nominal. I work in the movie industry, so I pay it [credit] off very quickly.”

Down the street, Los Angeles veterinarian Mamdouh Diab, 55, and his teenage son, Steven, were looking at used $15,000 Toyotas under a warm winter sun.

Not long ago, Diab feared that ripples from the Asian financial crisis would reach the United States, but those worries have faded. Now he plans to borrow more than half the cost of his auto purchase, and news of rising rates is not likely to stop him.

“Not at the pace it’s going up, a quarter point, half a point,” he said. Rates would have to shoot up 3 or 4 percentage points to get his attention.

The Federal Reserve will come face to face with such concerns this week. It cannot escape the paradox of prosperity: Boom times historically sow the seeds of their own demise.

A torrid economy ultimately runs short of workers or key materials, leading to price hikes, demands for higher wages and wrenching shortages. To preserve the good times and prevent an outbreak of inflation, the government’s arsenal amounts to virtually one weapon: interest rate hikes. The idea is to discourage people and companies from spending so much.

Yet as some economists see it, the economy is growing less sensitive to interest rate shifts.

The soaring stock market has provided corporate America with ample capital resources for new projects as an alternative to borrowing. Years of brisk profits provide yet another source of cash to pay for expenses.

Consumers, who drive two-thirds of the $9-trillion U.S. economy, have been showered with a multitude of low-cost credit options, including new types of mortgages and cheap auto loans, further offsetting the impact of Fed rate hikes. What is more, the stock market has transformed the psychology of many consumers, creating a sense of affluence that does not depend only on their paychecks.

The danger for the Fed is that in switching from a tuning fork to a hammer, officials could create the very episode of hard times that they wish to avoid.

“We have more flexible credit arrangements than we had in the past,” said James F. Smith, chief economist with the National Assn. of Realtors. But he cautioned, “That doesn’t mean you can’t kill the goose if you raise interest rates enough--because assuredly you can.”

If there is one area in which rising interest rates have exerted a noticeable, albeit modest, effect, it is housing. Rates for 30-year fixed mortgages have been creeping upward from about 6.75% in late 1998 to about 8.25% today. That boosts the monthly payment on a $200,000, 30-year mortgage by a formidable $205 and prompts second thoughts among buyers.

In the process, activity has eased, yet only slightly. Buyers have already begun shifting to adjustable-rate mortgages to avoid the higher monthly cost, an example of the credit options that give consumers flexibility these days.

At the beginning of 1999, housing starts were running at an annual pace of 1.8 million; more recently, the figure has settled closer to 1.65 million.

In an economy with so much momentum, the challenge facing the Federal Reserve comes down to a question: How high is too high?

The dilemma is made even more complex by the lack of evidence of inflation. A widely watched index of employment costs rose 1.1% during the last quarter of 1999, high enough to draw attention but not to trigger many alarms.

Technology, intense competition and determined cost-cutting persuade many experts that inflation poses less of a threat to the current expansion than it did in the past, and that the Fed therefore does not need to raise rates very much.

“I have quite a bit of confidence in the Fed policy, based on their track record,” said Philip R. Sherringham, chief financial officer at Sanwa Bank California in Los Angeles. “It’s easy to be a critic, but they’ve managed to walk this very fine line in a very successful way.”

Grasping a shopping bag in the heart of Seattle’s retail district, Shirley Phelps may symbolize the challenge facing Fed officials as they seek to steer America’s expansion into further uncharted territory.

Phelps, 54, and her husband are looking forward to a home remodeling project, and even with rising interest rates that could push up the cost, the time seems right: “I think the rates would have to go up a lot for us to put that plan on hold. We’ll probably just look around for the lowest rate we can get and go ahead regardless.”

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Longer, but Not Stronger

The growth of economic output in the 1960s and the 1990s, on a scale in which output for 1961 and 1991 is set at 100. The economy grew faster in the 1960s, but stopped growing in 1970. The growth that began in the 1990s is continuing and even accelerating.

*Consensus estimate

Source: U.S. Commerce Department

* Times staff writer Bettina Boxall in Los Angeles and Times researcher Lynn Marshall in Seattle contributed to this report.