WASHINGTON -- The Federal Reserve Board's historic anti-inflation experiment is nearing a critical point both for the U.S. economy and for President Clinton's political prospects.
Financial markets generally believe the central bank's bold strategy to prevent the emergence of inflation with pre-emptive increases in interest rates will lead to a major economic slowdown or a recession in 1995 or 1996.
If the economy slumps, it will no doubt generate more controversy than usual. The downturn would be engineered by a central bank headed by Fed Chairman Alan Greenspan, a Republican, just about the time the political campaign in which Clinton is expected to seek a second term will start to heat up.
Some economists disagree that the central bank will engineer a recession. They maintain the independent monetary agency's interest-rate moves have an even chance of succeeding and extending the economic expansion for several more years. But all agree that the bank's current moves are critical.
"This is the moment of truth," said Steve Roach, economist for New York-based Morgan Stanley, the investment banking firm.
"Markets are
poised and are betting on the classic boom-bust cycle. But I think the Fed's moves are well-positioned to extend the recovery."
"We've never had a soft landing, but this time we might have one," said David Jones, economist for Aubrey G. Lanston & Co. of New York, a government securities firm. A "soft
landing" refers to an economy that settles into moderate, noninflationary growth for years.
Mr. Greenspan made it clear to Congress this week that he and the agency he heads are absolutely determined to continue on their course of increasing interest rates despite rising criticism from liberal Democrats.
So far Mr. Clinton has refrained from criticizing the central bank, for fear of the negative impact it would have on financial markets. Yet the president has made it clear he and his economic advisers do not see any signs of a new wave of inflation.
While Mr. Clinton has not benefited politically from the economic recovery, a major slowdown or recession that occurs around the time of the 1996 election could do severe damage to his re-election chances. No matter if he protests, the president has a major stake in the success of Mr. Greenspan's gamble to keep inflation in check.
The president has gone along with Mr. Greenspan so far because, as one economic adviser put it, the American middle class suddenly holds more financial assets than ever and is more concerned about inflation eroding their holdings.
Most economists expect that the Fed will push up interest rates by
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another 1 to 1.5 percent over the next four months. The hope is that this should be enough to cool off the economy without causing a recession, Mr. Roach said; but financial markets fear ,, the worst, a downturn triggered by interest-rate hikes that could soon drive mortgage rates beyond 10 percent. The average rate for a home loan now is about 9 percent.
The Republican victory in last month's midterm elections gave Mr. Greenspan more leeway to pursue his aggressive anti-inflation stance without fear of political criticism, said economist Michael Drury of Memphis-based McVean Trading Co., an investment banking company.
"He was feisty in his testimony. . . (before Congress' Joint Economic
Committee)," Mr. Drury said. "He seemed to be saying to his Democratic critics, 'I'm going to be retired before you are in the majority again.' "
Early this year, the central bank made a major decision to start pushing up interest rates even though there was no sign of inflation in the economy. The move was made to counter criticism that it has generally waited too late to increase interest rates to slow down a robust economy. Although liberal Democrats protested, Mr. Clinton passed up one chance after another to criticize Greenspan and his Fed, even when mortgage interest rates climbed in recent weeks. But David Wyss, economist at the Lexington, Mass.-based economic consulting firm of DRI/McGraw Hill Inc., said he is betting that Mr. Greenspan will beat the odds and avoid a recession.