The Federal Reserve did not raise short-term interest rates yesterday, surprising many who had predicted otherwise and furnishing new evidence that Fed policy-makers are rethinking conventional wisdom about sacrificing U.S. jobs in return for a stable currency.
Many economists believed that an Energizer Bunny economy, very low unemployment and signs of higher wage inflation would prompt the Fed to push its overnight funds rate from 5.25 percent to 5.5 percent. For two decades the Fed has boosted rates with far less provocation, in the cause of cooling warm economies and quelling price increases.
Respected Fed watcher James Annable said last week that a rate rise this week was as sure as a playoff berth for the Cleveland Indians -- and the Indians had already clinched. An unusual news leak this month describing the inflation worries of Fed governors helped reinforce that view.
Yesterday's act of passivity by the Fed "is utterly extraordinary," said Annable, chief economist with First Chicago NBD. "Basically, they're taking a pre-emptive strike on price inflation out of their quiver."
Other economists were less forthright but still impressed by the tTC outcome, which became apparent after the meeting of the Fed's Open Market Committee ended around 2 p.m.
"The Fed has now opened itself to accusations -- unfair in my opinion -- that it has fallen behind the proverbial curve" on fighting inflation, said Bruce Steinberg, economist with Merrill Lynch & Co. in New York.
Investment markets hemmed and hawed after the meeting, with the Dow Jones industrial average initially rising more than 30 points but closing down 20.71 on the day at 5,874.03. The bond market traced a similar path, popping in midafternoon but giving up some of the gains later. The yield on the U.S. Treasury's main 30-year bond fell to 6.98 percent from 7.02 percent the day before.
Since the 1970s, economists have believed that unemployment rates of much below 6 percent would dry up sources of skilled labor and compel companies to raise wages and fuel inflation. Because monetary policy takes at least a year to effect economic change, the Fed traditionally has taken a pre-emptive approach to inflation busting, raising rates when unemployment falls -- but before prices rise significantly.
But many policy-makers and economists argue that inflation is, if not dead, then far less of a threat than once. Forces ranging from global competition to declining unions to debt-strapped families have made it more difficult for producers to boost pay and pass new costs to consumers.
As evidence, they point to recent statistics: U.S. unemployment has been below 6 percent for almost two years. The August 5.1 percent jobless rate was the best since the 1980s. The "core" rate of inflation, excluding food and energy, is just 2.7 percent. And many economists, Fed Chairman Alan Greenspan included, believe that government inflation gauges overstate real price increases.
The Fed's lack of action yesterday is something of a victory for people who think the nation's central bank should worry less about inflation and more about letting the economy add jobs and grow.
"The jury is still out on whether the present unemployment rate is inflationary or not," said Allen Sinai, chief economist for Lehman Brothers in New York. "So why not wait and see?"
But there were reasons beyond economic theory for the Fed to leave rates unchanged yesterday. The economy, while growing at a robust 4.8 percent annual rate in the second quarter, may be decelerating without any help from Greenspan.
"There are very strong signs of slowing down," said Charles McMillion, chief economist with MBG Information Services in Washington. "Debt levels are high. Savings are low. Retail sales are extremely weak, and we're going into an important Christmas buying season."
Some analysts thought the Fed avoided any change to avoid the appearance of influencing the election, although Annable of First Chicago dismissed that scenario.
Several economists believe the gross domestic product is growing at only a 1.5 percent or 2 percent rate now and will end up growing by a little less than 3 percent for the whole year.
Pub Date: 9/25/96