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| RAISING THE RATES | |
 June 30, 1999 
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As was widely anticipated, the Federal Reserve increased the short-term interest rate by a quarter-percentage point to 5 percent. It was the Federal Reserve's first rate increase in two years. Business correspondent Paul Solomon and guests discuss the move and what it means for the economy.
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PAUL SOLMAN: The Fed's action today, the first rate hike in more than two years, comes after weeks of Chairman Alan Greenspan's warning that an overheating economy could fuel inflation.
PAUL SOLMAN: Now, "Greenspan Speak" can also be pretty opaque to penetrate, but most observers thought they knew what the Chairman meant this time around, especially since the Fed announced it was leaning toward a hike after its last meeting six weeks ago. (Applause)
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| Interpreting the increase. | ||||||||||||||||||||
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PAUL SOLMAN: To interpret that statement and today's move we're joined
by David Jones, chief economist at Aubrey Lanston, a government bond
dealer; Michelle Laughlin of Prudential Securities, a Wall Street brokerage
firm; Richard Trumka, secretary-treasurer of the AFL-CIO; and Alan Meltzer,
Professor of Political Economy at Carnegie Mellon University and a visiting
scholar at the American Enterprise Institute. And, welcome to you all.
PAUL SOLMAN: Well, so what are the effects? Buyers pay, on average, a quarter of a percent more, is that a fair statement, it just transfers directly? DAVID JONES: Well, one thing we might say is that market interest rates, particularly long-term interest rates, both bond yields and fixed rate mortgages, have already moved up in anticipation of the Fed's move, so in some ways the markets were already correcting higher, thus raising borrowing costs for people. What the Fed is really trying to do is cool off the economy a bit. Demand growth is extremely strong. Autos are booming. Housing is booming. The fear is that if the Fed allows this to get away from them, we could end up with too much of a good thing in terms of growth. So the idea is to hike interest rates enough to cool that growth off a bit, but the act today was a relatively small step in that direction.
RICHARD TRUMKA, AFL-CIO: Yes, there sure are. First of all, let me start off by saying there is no objective evidence that this economy is overheating, and we think that he should have let the economy go on and expand so that everybody could have enjoyed the benefits of an expanding economy. Those at the bottom end of the spectrum, those that you're seeing workers down at the bottom end of the spectrum, are just now beginning to enjoy the benefits of this marvelous economic expansion and they're going to have that door shut on them. African Americans still have 7.7 percent unemployment rate, Latinos around 7. Wage growth for them was just starting to edge up and just as likely to shut the door on them. You'll see consumers pay a price; you're going to see small businesses pay more for their lending, and you're also going to see struggling third world countries that are going to pay a price by this today. PAUL SOLMAN: When you say shut the door on them, you mean you think this will slow the economy enough to actually cost people jobs or prosperity? RICHARD TRUMKA: I think they're going to get a bite two ways. They're going to pay more for their mortgages, their credit cards, their lending. Small businesses are going to be less likely to expand to provide jobs at the bottom end of the spectrum and there is going to be less money to pay for raises at the bottom end of the spectrum. PAUL SOLMAN: Michelle Laughlin, do you agree with that?
PAUL SOLMAN: Long bond yields meaning the bonds that you borrow for a long period of time. MICHELLE LAUGHLIN: Exactly. Currently, that's holding right around a 6 percent mark. Today the Fed raised the Fed Fund's rate to 5 percent, so you see that the Fund's rate is still well below the level of bond yields, and I think that, therefore, I think you'd need to see the Fund's rate move to significantly higher before you'd be talking about it, or I would say worrying about a meaningful slowdown in the U.S. economy. PAUL SOLMAN: So then why does he do it, Allan Meltzer, if it has a negligible effect, why make any move at all? |
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| Reacting too late? | ||||||||||||||||||||
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PAUL SOLMAN: So what does that mean? ALLAN MELTZER: What that means is that people in the markets were expecting more than what he did; that is, they expected 25 basis points, the move that he made, but some continuation of that policy. They made an announcement which said, well, they're taking away the bias toward further tightening. I think they'll correct that as they go along, but what they did today was certainly not enough, and it certainly isn't going to raise mortgage rates. Mortgage rates have already moved higher in anticipation of what the Fed was likely to do, and now they're likely to come down a little bit as a result of the easing in the bond market today. PAUL SOLMAN: So you mean you think he juiced the economy, in other words, by not raising as much as you would have had him to? ALLAN MELTZER: That's right. As a matter of fact, he did ease up relative to where people thought he was going to be. So that's a move to ease. I mean, everything in this business depends upon what you do and what people expect you to do. What people were expecting him to do was to take action which was more forceful than the action that the Federal Reserve took today. So in that sense, it's easier not tighter, and they're going to have to do a lot more to get demand down. Now, people say -- people make the mistake, many of them, that say, this is a move which is going to hurt workers or hurt job seekers. That's not true. The best thing that we can do for workers and job seekers is to keep the economy from getting overheated and having too much demand growth. And we're in the danger of having too much demand growth now. And it's important to slow it down and to do it more quickly than the Federal Reserve seems of a mind to do. PAUL SOLMAN: Well, Richard Trumka, you keep making noises here in Washington - RICHARD TRUMKA: I'm just happy that the Fed didn't listen to Allan, because when the unemployment was at 6 percent, Allan was saying, raise the rate. When it was at 5 percent, he was saying raise the rate.
RICHARD TRUMKA: When it was at 5 percent he said raise the rate. ALLAN MELTZER: That's absolutely not true. RICHARD TRUMKA: Let me answer. I let you answer. PAUL SOLMAN: Just in fairness, you may not have, Professor Meltzer, but we certainly had people on this show who kept arguing from your point of view who said, yes, now's the time, now's the time, unemployment is too low, too low. RICHARD TRUMKA: And had they listened to them, we would have been denied all the benefits of this expansion: Higher wages, higher productivity and lower unemployment. So it's a good thing that that didn't happen. There's also no evidence, no evidence that this economy is overheated. You still have tremendous manufacturing capacity. You still have a greater labor participation rate. It continues to grow. You still have gross end productivity there exceeding any wage rates. All of those are exceeding what he said. So we would like to see the economy expand out a little bit more, and the people at the bottom not get hurt. Now, you remember Rubin just left. Secretary Rubin said, "He's not worried about inflation." His fear was about the trade deficit. This move will make more imports come into the country and increase his biggest fear.
DAVID JONES: I was itching to get into this, as you might have guessed.
I come in on Allan's side. One of the potential imbalances -- it's difficult
to know how severe it is, but one of the imbalances is the fact that
consumers have tied their spending more and more to this escalating
stock market and actually driven their savings rates down to negative
territory. There is no more saving for a rainy day in the old-fashioned
sense of the term. The danger is how close are we to a stock market
bubble? The scenario that could happen here is if the markets do lose
faith in Chairman Greenspan's ability to keep us on a steady, sustainable
course without inflation, would be the stock market soars higher, spending
gets even more out of control, and then everybody will be in agreement
that the strains on the labor market are simply too great, leading to
higher wage and price pressures. The one thing the Fed has trouble controlling,
except through credibility, is that stock market. I can't say for sure
it's in a bubble condition right now. But I think it's getting close
to it in terms of sort of speculative buying that goes higher and higher.
It's a danger, and indirectly, Fed credibility in keeping things in
check also keeps the stock market more under control. Today there was
no evidence whatsoever after the Fed took its PAUL SOLMAN: So you think that maybe the fact that it went up 155 is not a good sign? |
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DAVID JONES: Well, the point is that you're going to reach a moment of a bubble-type economy where stocks are simply too high. And then the danger is something bursts that bubble, and it turns us into a severe downturn. The idea of keeping the economy on a sustainable pace means keeping the economy in balance. And the one area where it looks like it could become out of balance is that stock market. PAUL SOLMAN: Michelle Laughlin, do you think the stock market was negatively affected in the sense that it was given even more of a euphoric boost today by the modest rise? That's what both -- that's certainly what David Jones was saying.
PAUL SOLMAN: The wealth effect meaning - MICHELLE LAUGHLIN: Meaning that as your stock portfolio increases in value you feel wealthier and therefore are more inclined to go out and spend. And what we've seen is consumers willing to go and spend beyond the amount of money that they're earning from their job. And that's why the savings rate has gone down. But I don't -- and so we've seen the strong demand, which has everybody concerned about the outlook for inflation. But you know, firms simply don't have pricing power. There isn't any evidence to date that the strong demand that we've enjoyed for the last several years is feeding through in the form of higher prices. The CPI core rate just on a year-over-year basis fell to a new low level from the mid-1960's. I actually see a risk more on the other side, that is -- what could be the fallout if the Fed did act very aggressively to raise rates? We still have a lot of vulnerable areas in the global economy. We had Colombia devalue their currency. The dislocations in the treasury market, the backup in long bond yields, the rise in interest rates here has now spilled over. We're seeing interest rates -- long-term interest rates in Europe rise. Their economies are really much weaker than the U.S. and will suffer as a result. So I think there are still global risks to a scenario of aggressive Fed tightening. This won't raise a lot of risks, this 25 basis point move -- but I have to say, though I'm clear about why you go back to a neutral stance after prepping the markets for tightening so long, the bottom line is I'm happy to believe that this is only going to be a modest adjustment in rates. PAUL SOLMAN: So, Allan Meltzer, usually we talk about the stock market going down when interest rates go up. Today the stock market went up 155, even though interest rates went up. That's because?
PAUL SOLMAN: Pump in money? But if they're raising money, aren't they tightening the money? ALLAN MELTZER: But not enough. And so the money is flowing into asset prices. It isn't true that we're not seeing signs of inflation, and it isn't true that companies don't have pricing power. 50 percent of the prices in the economy are rising at a rate of 2 ½ percent a year or more. And what's happened is that we have a mirage of very low inflation because steel prices have fallen very rapidly, copper prices. Almost all of them, the prices that have fallen, oil priorities for a long time fell, almost all of those prices have nothing to do with superior productivity growth. They have to do with the fact that the rest of the world has been slumbering. Now they're recovering. As those companies recover, then the rate of inflation is going to move up in the economy to or thereabouts. And the Fed has to act now to try to prevent it from going higher than 3 percent. The market has already raised its expectation this year from 1 percent to 2 percent. And before the end of the year I believe they will be at 3 percent. So the Fed had to get ahead of the market and try to cool that off while we still have a chance to do this with very little harm to employment, production, and output in the U.S. economy. The Fed's job is not to look at what's happening today, it's to try guess what's going to happen a year or two years from now and to begin to slow down the economy now before we get into inflation, before the inflation gets imbedded in wages and we go through cycle in which we have to try to drive it out. PAUL SOLMAN: Okay. Well, gentlemen, Ms. Laughlin, we'll leave it there. And I'm sure we'll be back to it maybe in six weeks even. |
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ALAN
GREENSPAN: For monetary policy to foster maximum sustainable economic
growth, it is useful to preempt forces of imbalances before they threaten
economic stability. But this may not always be possible - - the future
at times can be too opaque to penetrate. When we can be preemptive,
we should be, because modest preemptive actions can obviate the need
of more drastic actions at a later date, and that could destabilize
the economy. 
It
was 12 years ago, in 1987, that Greenspan was first tapped to steer
the economy. The key short-term interest rate, the Federal Fund's rate,
was at 6.75 percent. And the next two years, Greenspan nudged it up
steadily to nearly 10 percent. Then in the early 90s the Fed began lowering
to boost the economy in the wake of the Gulf War turndown. Rates reached
a bottom of 3 percent. But as the economy recovered in the mid '90s,
so did the Fund's rate, which the Fed last raised in March of 1997,
finally afraid the economy was growing too fast. Last fall, however,
it reversed course again, to bolster the U.S. economy amidst a global
financial crisis. 
Meanwhile,
during Greenspan's 12-year tenure, the overall economy grew at a healthy
3 percent a year in the late 80's, and though interrupted by the contraction
of '91, resumed its growth, the last two years at almost 4 percent.
As for the stock market, the Dow Jones Industrial Average was at 2680
the day Greenspan became Fed Chairman. After the October crash in '87,
it has soared with few dips. 
Today,
it hit 10,971, up 155. As for today's rate rise, it was the smallest
possible, and the Fed also said that there was no bias in favor of future
hikes, ending on a note of caution, saying it "recognizes that
in the current dynamic environment, it must be especially alert to the
emergence, or potential emergence, of inflationary forces that could
undermine economic growth." 
DAVID
JONES, Wall Street Economist: Well, the Fed took a very modest step
in a tightening direction by hiking interest rates, but we have to remember
that it was only a quarter of 1 percentage point, a very modest move,
hiking the so-called overnight fund's rate from 4 3/4 to 5. If we look
at it in terms of what -- how much more money borrowers buying a home
will pay, it's relatively insignificant in terms of this one step.
PAUL
SOLMAN: Anybody have any thoughts on other effects? Are there, Richard
Trumka?
MICHELLE
LAUGHLIN: Well, you know, historically you haven't seen the economy
slow from Fed rate hikes until the yield curve inverts, that is, until
the Fed Fund's rate exceeds the level of long bond yields. And we're
still a long way from that. 
ALLAN
MELTZER, Carnegie Mellon University: Well, in fact, he's way behind
the curve. He's much too late, and he did much too little - they --
we should say -- did much too little. Mr. Trumka's just wrong. The reaction
in the bond market today was for bond yields to come down and the same
thing in the stock market; the stock market boomed, 100 points immediately
on the announcement.
ALLAN
MELTZER: That's not true. 
PAUL
SOLMAN: Let's go to David Jones for a second. Mr. Jones, what do you
think of whether or not this was the right thing to do? Are there signs
of overheating? Did he need to put on the breaks and so forth? 
small
step that the stock market was under control.
MICHELLE
LAUGHLIN: Right. No, I tend to fall -- this evens out - because I tend
to fall on the other side of the issue. You know, I don't know, and
I don't think that Fed Chairman Greenspan can know or anybody at what
level the stock market is overdone. It's blown through so many levels
that people thought would mark a top. And I just don't necessarily think
that the Fed should be targeting the stock market, and not that the
Fed chairman is; he pays attention to asset prices. Clearly the wealth
effect from rising prices has fed back through to this economy. 
ALLAN
MELTZER: That's because the Fed is pumping in money at a very high rate,
and they're going to continue at these rates to pump in money at a very
high rate. 
