March 25, 1997
Is the economy growing too fast? Is inflation just around the corner? The Federal Reserve apparently thinks the answer is yes to both these questions because it applied the brakes to the economy today by raising a key interest rate. Why are Alan Greenspan and the Fed back in anti-inflation mode, should they be, and how will the interest rate hike affect us?
JIM LEHRER: The raising of interest rates is our lead story tonight. Economics Correspondent Paul Solman of WGBH-Boston begins our coverage.
PAUL SOLMAN: Is the economy growing too fast? Is inflation just around the corner? The Federal Reserve apparently thinks the answer is yes to both these questions because it applied the brakes to the economy today by raising a key interest rate. The Fed increased the Federal Fund's target rate by 1/4 percentage point, upping the rate to 5 ½ percent. The number is the interest rate banks charge each other for overnight loans, and many use it to compete their prime rate of interest to borrowers. And several banks did raise their rates this afternoon after the Fed's announcement.
Now, the Fed has not changed the Federal Fund's rate in more than a year, after a pretty active decade of intervention. In the booming economy of the late 1980's the Fed was raising rates all the way to 10 percent to choke off inflation. But the economy went into recession, and so in the early 90's the Fed began lowering interest rates down as far as 3 percent. As the economy began expanding once more, the Fed resumed its role as inflation tamer and began, once more, to raise rates which reached a recent high of 6 percent in March of ‘95. Signs of the economic weakness led to a few downward adjustments to the 5 1/4 percent that has prevailed for more than a year. But lately, there's been evidence that Fed Chairman Alan Greenspan was again worried about an overheated the economy and inflation.
ALAN GREENSPAN, Chairman, Federal Reserve Board: Given the lags with which monetary policy affects the economy, however, we cannot rule out a situation in which a preemptive policy tightening may become appropriate before any sign of actual higher inflation becomes evident. Indeed, the hallmark of a successful policy to foster sustainable economic growth is that inflation does not rise.
PAUL SOLMAN: Today, the chairman's warning became policy, with a quarter percent rise in rates. So why are Greenspan and the Fed back in anti-inflation mode, and should they be? For some answers we're joined by Harvard economist Martin Feldstein, who chaired the Council of Economic Advisors under President Reagan, and economics writer Robert Kuttner, editor of the "American Prospect," a liberal journal. His most recent book is "Everything for Sale: The Virtues and Limits of Markets." Gentlemen, thanks for coming by. Mr. Feldstein, the Fed said today this was a "prudent step to prolong the current economic expansion by sustaining low inflation. Do you agree with that?
MARTIN FELDSTEIN, Harvard University: I do.
PAUL SOLMAN: Would you explain why.
MARTIN FELDSTEIN: Well, in the past, the recent that expansions have come to an end is that we tended to have rapidly rising inflation, and that required a sharp turnaround. This way the Fed is just trying to keep things from overheating.
PAUL SOLMAN: When you say sharp turnaround, what do you mean?
MARTIN FELDSTEIN: I mean, the Fed in the past, for example, in the late 1980's--the late 1970's have to really step on the brakes very hard, raise interest rates dramatically, push the economy into recession. That's exactly what Alan Greenspan and his colleagues are trying to avoid this time.
PAUL SOLMAN: So this is the famous going against the wind, navigating.
MARTIN FELDSTEIN: Just keeping the economy from getting too hot so that inflation starts rising again.
PAUL SOLMAN: All right. So, Mr. Kuttner, what's wrong with hiking interest rates in order to keep us on an even keel?
ROBERT KUTTNER, Economics Writer: Well, I think the Fed has an itchy trigger finger. I think they're much more averse to inflation than they are to unemployment. The economy is only growing at 2.2, 2.3 percent a year. It can probably do better than that. Unemployment is, you know, 5.3, 5.4 percent. We can probably get it down lower than that. And as Greenspan, himself, admitted in his recent testimony before the congressional Joint Economic Committee, in January and February the core inflation rate was only 2.3 percent. That's a full point lower than it was last year. Greenspan also acknowledged that for the most part the slight wage increases have been matched by productivity increases. So I think this is jumping the gun. And I think the reason is that the Fed's constituency is bankers, it's creditors, it's people who have an almost phobic aversion to wages going up. And wages going up is what this economy needs.
PAUL SOLMAN: Well, maybe you're jumping the gun for a second because you're getting ahead of our argument. Mr. Feldstein, where is the inflation? What's the evidence for it? Mr. Kuttner points to--
MARTIN FELDSTEIN: The inflation is fortunately quite low, and that's what the Fed wants to keep it at, wants to keep the inflation rate from bouncing back up again to 3, 4 percent. If you ask what the financial markets are expecting about the future, they're expecting inflation to come up. If you look at the surveys or if you look at the long-term interest rates, they both point to a fear of higher inflation. And one way of interpreting what the Fed did today was to send a signal to them that it's not going to let inflation rise.
PAUL SOLMAN: But is there any evidence of inflation, besides the fact that people such as yourself and the Fed, apparently, think that it might happen?
MARTIN FELDSTEIN: Well, for example, the purchasing agents, these are the people who work for companies and buy the products that companies buy and put into making other products, so the purchasing agents are surveyed every month about what's happening to the prices they pay. In the most recent data that we have, the data for February showed one of the sharpest increases in a percentage of those purchasing agents reporting an increase in the prices that they were paying. So that's really the front line buyer before it becomes a consumer price, the companies are seeing their inputs going up in price.
PAUL SOLMAN: All right. So there's data for you, Mr. Kuttner.
ROBERT KUTTNER: Yes. Except that the core inflation rate, as recently as February, was not going up, and the slight wages increases that were finally experienced by workers who really haven't benefitted for the most part from this recovery, according to Chairman Greenspan, himself, were matched by productivity increases. I think some of this has to do with internal Fed politics. Greenspan has been relatively dovish, compared to some of the other members of the Open Market Committee.
PAUL SOLMAN: When you say dovish, please explain what you mean.
ROBERT KUTTNER: A little bit less inclined than some of his colleagues to slam on the brakes. And I think some of this had to do with Greenspan's own credibility with his colleagues, rather than real economic factors.
PAUL SOLMAN: Mr. Feldstein, internal politics? Do you think that's been playing a role here?
MARTIN FELDSTEIN: No. I think this is just over-interpreting it. I think the Fed is simply trying to do two things: One, to keep the economy from overheating, and two, and probably more importantly, to send a signal to the financial markets that the Fed is serious about inflation. And by sending that signal we keep longer-term rates from rising. We keep mortgage rates from going up.
PAUL SOLMAN: You know, you were going to say something.
ROBERT KUTTNER: I was going to say I guess that's my broader criticism of the Fed; that it's too sensitive to what it thinks financial markets might think--the financial markets are doing very well lately, but the rest of America is not doing quite so well--and not sensitive enough to the real economy.
PAUL SOLMAN: Well, what about low unemployment here? I mean, you've been talking--I remember interviewing you several years ago when you said 6 percent is the lowest we could get, and the Fed had to raise rates because the economy was going to overheat.
MARTIN FELDSTEIN: I think we've all been very surprised, pleasantly surprised.
PAUL SOLMAN: Are you embarrassed at all, that you had the wrong--
MARTIN FELDSTEIN: Well, I think the economics profession should be a little embarrassed, me too, but I think the profession as a whole has to recognize that the economy has been able to deliver a lower unemployment rate than we expect. And I don't think that the low unemployment rate is a reason for raising inflation at this point. We've had the unemployment rate at this level for about a year, but we are beginning to see signs, as I indicated, of purchasing agents prices or showing that wholesale prices at that level are going up and are going up more rapidly.
ROBERT KUTTNER: I think there have been profound structural changes in this economy because of globalization, because of the relative weakness of labor's bargaining power, which accounts for the fact that the unemployment rate can go lower, and a lot of economists thought it could go without triggering inflation. And I think once again the Fed is jumping the gun.
PAUL SOLMAN: Yet, you know, the current "Business Week" has an editorial, the magazine, Mr. Feldstein, and says, it's a whole new ball game, Mr. Greenspan. It argues that wage inflation is no threat, but a downturn in high technology is. In that case, says Business Week, "an interest rate rise just might deflate an entire economy." That's "Business Week" Magazine.
MARTIN FELDSTEIN: We're talking about a quarter of 1 percent. This is really very small. It is, it is minute in terms of its impact on the actual economy. It is important as the signals that the Fed's serious about inflation, and that companies shouldn't start raising prices, eroding the purchasing power, that long-term mortgage rates shouldn't be pushed up in anticipation of future inflation because the Fed is not going to let that happen.
PAUL SOLMAN: So it's symbolic.
ROBERT KUTTNER: Well, but this is an economy that's sort of chugging along at 2.2, 2.3 percent growth.
PAUL SOLMAN: Higher in the last--higher in the last quarter of ‘96. 3.9 is the latest number.
MARTIN FELDSTEIN: This current quarter to be over 3 percent again.
ROBERT KUTTNER: But I think that's cause for celebration. It's almost as if as soon as the economy starts growing at a decent rate the Fed feels that it has to throw cold water on it.
MARTIN FELDSTEIN: No, not at all. I think the economy is doing well. I think that Chairman Greenspan has said that the economy is doing well, but nobody wants to see it fall off this track by suddenly getting into a spiraling inflation.
PAUL SOLMAN: There was one other question I wanted to ask you, Mr. Kuttner. Lester Thoreau, among others, has on this show said that the Fed has raised rates too high in recent times and is spiteful of the economy's potential for growth. Do you agree with that?
ROBERT KUTTNER: I do, yes. I think Prof. Feldstein is right; that long-term interest rates are almost double historic averages. But we can argue about whether that's the fault of the Fed, or whether that's the fault of expectations of financial markets.
MARTIN FELDSTEIN: Well, it's the expectations of financial markets fearing inflation.
PAUL SOLMAN: Let's talk about those markets for a minute. Mr. Feldstein, Chairman Greenspan's taken a lot of heat lately for remarks about an overheated stock market and rational exuberance and so forth. Does the Fed take such things into account in its planning, and, if it does, could you explain the link?
MARTIN FELDSTEIN: I think the Fed looks at lots and lots of things, including the stock market, including the stock market, a fear that perhaps by feeding too much credit into the system it has allowed the stock market, encouraged the stock market to be too hard.
PAUL SOLMAN: And that's what you do with low interest rates. You feed more credit into the system.
MARTIN FELDSTEIN: We all saw what happened in Japan, for example, where the Japanese were encouraged to have very low interest rates, and created what they called the bubble in which the stock market rose to incredible heights and then collapsed. And that's certainly something that the Fed wants to avoid.
PAUL SOLMAN: You're shaking your head, Mr. Kuttner.
ROBERT KUTTNER: Well, but in this economy if the core inflation rate is below 3 percent and short-term money is 5 1/4 percent, 5 ½ percent, and long-term money is 7 percent. That's hardly the case of real interest rates being so low as to stimulate the credit boom.
PAUL SOLMAN: I have one more question. Mr. Feldstein, you're a classical economist. Are you at all skeptical of the Fed's ability to affect the stock market, to calibrate the economy as a whole?
MARTIN FELDSTEIN: I don't think anybody believes that we know what the impact is of the 25 basis points change like this.
PAUL SOLMAN: That's 1/4 percent, right?
MARTIN FELDSTEIN: 1/4 percent change of the sort we had today. I think that's why--I emphasize that it's clearly sending a signal, sending a message, telling the economy, don't think inflation, think price stability, because the Fed is going to keep us moving toward price stability.
PAUL SOLMAN: All right. Well, gentlemen, thanks very much.
JIM LEHRER: Now to an additional look at the consumer fallout from the Fed decision and to Elizabeth Farnsworth.
ELIZABETH FARNSWORTH: To find out how the interest rate hike will affect everything from our credit card bills to auto loans we turn to Anne Kates Smith, "U.S. News & World Report's" senior editor for personal finance. Generally, how will this affect the average American consumer?
ANNE KATES SMITH, U.S. News & World Report: I think consumers won't feel very much of a pinch in their pocketbooks at all. As you've mentioned, the prime rate went up today at several banks, and consumer loans that are tied directly to the prime will go up immediately 1/4 percentage point. When you do the arithmetic, as my friends at the Bank Rate Monitor have for me, that comes out to not very much at all--on a credit card, a 16 percent credit card balance of say $3,000, you're paying another $7.50 a year. Home equity loans are also tied right to the prime, and they'll go up from about 9 ½ to 9 3/4, and mortgage loans will--although they're not tied directly to the prime--they will rise in sync, some adjustable rate loans. On a $100,000 loan that comes out to $17 a month. And that's not much of a pinch.
ELIZABETH FARNSWORTH: What about auto loans?
ANNE KATES SMITH: Auto loans will barely budge at all. That works out to say a $20,000 car loan, four-year loan, that works out to about $2. That's less than $100 over the life of the loan.
ELIZABETH FARNSWORTH: If I were about to buy a house--I have an acquaintance in this situation--if I were about to buy a house, would it be a good idea to do this now and--or wait a little bit?
ANNE KATES SMITH: I wouldn't advise people to go out and shop for a house if they weren't in the market. If they're in the market, it's a good time to lock in rates. The direction has changed. Rates are up. People are already looking forward to the next rate hike. Whether we get one or not, markets will start anticipating that, and I think it behooves consumers if they're shopping for a home to lock in rates. If they're going to remodel their house and they want a home equity line, line it up now.
ELIZABETH FARNSWORTH: So even though it's fairly small, the rate hike, you get this sense that there's this directional change and people had better--people will start thinking about that, no matter what.
ANNE KATES SMITH: Interest rates tend to run in cycles. And the last direction we've seen is up.
ELIZABETH FARNSWORTH: What about--let's say that tomorrow I had planned to go in and task for a raise, and I'm a worker, and I want a cost of living increase. Does this affect an employer's view of that kind of question?
ANNE KATES SMITH: Employers will probably feel--
ELIZABETH FARNSWORTH: They want it to affect it, right? Isn't that part of Greenspan's point, so that there won't be wage pressures?
ANNE KATES SMITH: Yes. And there will be less pressure on your boss to give you a raise. This is not a great time to go ask for a raise, I imagine.
ELIZABETH FARNSWORTH: So maybe put that off. Will it affect people's savings?
ANNE KATES SMITH: Not very much, because savings rates don't follow increases in loan rates as quickly. You're not going to see your CD rate go up. You're not going to see your money market rate go up very much, if at all. So it shouldn't really affect your savings plan.
ELIZABETH FARNSWORTH: And if savings are in the stock market, is it likely to change? Are they--is that likely to have any movement?
ANNE KATES SMITH: That's the million dollar question. And we don't know the answer to that. Interest rate hikes have been disastrous for some past markets, especially markets that are very highly priced like this one is by many measures. A 1/4 point rate hike is not enough to shift the balance. Nobody I'm talking to expects the stock market crash. Again, the market is a psychological thing, as much as anything else. And people will look forward to the next rate increase, and that could have an impact.
ELIZABETH FARNSWORTH: You expect there will be another increase in May or June.
ANNE KATES SMITH: I talked to people who expect another 1/4 point in May.
ELIZABETH FARNSWORTH: Well, Anne Kates Smith, thanks for being with us.
ANNE KATES SMITH: Thank you.
JIM LEHRER: Still to come on the NewsHour tonight Congress and campaign money and some thoughts about the Bush jump.