With the election campaign ended and the economy still buoyant, many economists expect that another bump in short-term interest rates -- the sixth since Feb. 4 -- is coming on Tuesday when the Federal Reserve's Open Market Committee meets. The focus is on the federal funds rate, which banks charge each other for overnight loans to meet the Fed's reserve requirements. How big will this week's increase be? Will there be another this year? What will rising interest rates do to the economy?
Paul Boltz
Chief Economist, T. Rowe Price Associates
So far, the Federal Reserve's interest rate policy has had only marginal effect on the economy. Commercial and residential construction have responded the most, because they are the most sensitive to interest rates, and even there the effect has not been very great.
The Fed will almost certainly tighten this week. The minimum is half a percentage point. But with unemployment under 6 percent, and wages starting to rise after a long period of moderation, I think they might well want to do something more dramatic to signal that they are determined to fight inflation.
They have several choices. They could go up three-quarters of a point instead of just a half, or they could include wording in the announcement to suggest that further steps are likely in the weeks ahead. They meet again Dec. 20, just before Christmas, so they could give us both a Thanksgiving surprise and a Christmas gift.
Based on history, they have plenty of room to go up still more. After the 1987 stock market crash, they wanted to invigorate the economy so they took the federal funds rate down to 6.75 percent, which was considered loose credit at that time. Today, we're two full points under that, at 4.75 percent. This is still essentially neutral territory.
Paul S. Lande
Senior Fellow, Johns Hopkins Institute for Policy Studies
I think they're likely to raise short-term rates this week, probably by another half-point. This is probably not the end of it. The Fed is responding to the pickup in economic growth, especially the higher wages, lower unemployment and higher capital utilization rates we've seen in the recent economic reports.
The impact of further interest rate increases will be some slowing in the economy and some help for the dollar.
The bond market has already responded to the prospect of higher short-term rates with lower bond prices and higher yields. The prime rate for corporate borrowing will go up, and with it some consumer loan and credit card rates. Housing construction also will be affected.
All of that is negative for the economy and especially negative for Maryland.
Housing construction is very important to the Maryland economic recovery, and we're sure to see further slowing of housing construction, not only the usual winter slowdown but also some residual effect even into the spring season, when you normally expect that things should be picking up.
David Donabedian
Chief Economist, Mercantile Bankshares Corp.
I think I'm not alone in expecting an increase in both the Federal Funds and discount rates. The amount will be at least a half-point, and I lean slightly toward thinking they will just go up that much, not more right away. However, the economy, especially the employment figures, are quite strong, including the first hints of wage inflation, so I have to say the chance of going up more than a half-point seems stronger now than it did a few weeks back.
Whatever they do now will not likely be the last increase. We expect to see the Fed continue to increase short-term rates well into the first half of 1995. We expect short-term rates to peak somewhere in the 6-7 percent range, so that's at least 1.25
points from where we are now. If the Fed were to act more decisively now, the peak might be closer to 6 percent, but if they dilly-dally and do things gradually as they have been doing, it will be closer to 7 percent.
No one action by the Fed is going to have a direct or immediate effect on the economy. You have to look at the cumulative effect.
Looking out a year, you have to see some slowing in the economy. I would advocate more decisive action now, but in fact you have 12 votes on the Open Market Committee. Two are Clinton appointees and doves. Two of the regional bank presidents are very hawkish. That leaves eight votes in the middle, including Chairman Alan Greenspan, who is himself a moderate in every sense of the word.
When they were lowering rates to fight the recession, they stuck to a gradualist approach and only in 1991, after two and a half years of frustration, did they finally come with a decisive 1-point drop in rates. I don't think their frustration level is that high yet, so I think they're not yet ready to move a full point in one stroke.