To tighten, or not to tighten: Fed's decision is 48 hours away


TWO MONTHS ago, the Federal Reserve raised short-term interest rates by a quarter percentage point to try to head inflation off at the pass. Inflation wasn't getting any worse, but the Fed said it was trying to be "pre-emptive" by kicking inflation when it was down.

On Tuesday, the Fed's Open Market Committee, which controls short rates by manipulating the money supply, gets a chance at another blow. Many economists believe that the Fed will tighten another quarter point -- "25 basis points," in loan lingo.

The economy grew at a torrid 5.6 percent annual rate in the first quarter, which could cause inflationary pressures. But reports last week on prices, in fact, showed no inflation. What will the Fed do?

Robert Sweet

Chief economist, managing director, Allied Investment Advisors

That's the $64,000 question right now. The way the numbers are coming in, there is no inflation. But the strong growth figure that came in for the first quarter -- 5.6 percent -- it appears that's still the number we're going to see when they revise it.

The mixed bag is, we have no inflation and a strong economy. The odds are right now that they will not increase rates, but they're pretty narrow odds. But in my opinion, I still feel that there is a need for another 25-basis-point increase as an insurance policy against inflation.

Bruce Steinberg

Chief economist, Merrill Lynch

The wonder economy just keeps on producing surprises. After more than six years of economic expansion, inflation remains completely absent. Indeed, there is deflation at the wholesale level.

The Fed faces a difficult choice. We believe that they want to tighten once more to make sure that demand remains moderate going forward. But recent economic reports make it hard to justify an immediate tightening at the May 20 meeting. It's a very close call.

But we believe that Fed officials want to tighten one last time to make sure that demand won't accelerate again.

Christine Chmura

Chief economist, Crestar Financial Corp.

I'm still expecting the Fed to increase the Fed funds rate target by another 25 basis points. We've seen a little slowing of economic growth, but don't forget we're coming off a very rapid growth rate in the first quarter, and so we're still looking at growth that's probably above the potential rate. I'm looking for about 3 percent GDP growth in the second quarter; most people are looking at 2.5 to 3 to 3.5.

The inventory buildup that we saw in the first quarter will take away some of the growth. But at this point, the consumer sector remains strong, and there are no large imbalances that would suggest that this economy is going to move toward significantly slower growth.

The labor markets remain tight. Manufacturing activity continues at a pretty good pace. Tight labor markets would cause inflation to accelerate if the economy doesn't slow. And again, it takes nine months to a year for the impact of a tightening to affect the economy.

Bill Cheney

Chief economist, John Hancock

I doubt the consumer price index report will carry much weight when the Fed deliberates on a rate hike. The only consideration will be for appearances.

The CPI is a lagging indicator, only telling us what inflation was, not predicting future risk.

Continuously tightening labor markets could become an inflation flash point. I think the Fed sees a threat there and wants to surpress it with a small hike.

Waiting to see inflation in the CPI before hiking rates is like waiting to see flames in windows before calling the fire department. At that point, you're just too late.

Sung Won Sohn

Chief economist, Norwest Corp.

I still think they will hike interest rates by a quarter point. Here are the reasons. Economic numbers say that momentum is slowing, and inflation right now is not a major concern.

But all these indicators are backward looking, not forward looking. The Federal Reserve should be concerned about inflation later this year and into 1998, not what happened yesterday or the day before. So, basically, the reason for hiking rates in March remains valid.

What [Federal Reserve Board Chairman Alan] Greenspan did in March was not a mid-course correction, but a change in the course of monetary policy. Up until March, interest rates have basically been moving sideways for quite some time. Now the direction of interest rates is up.

But economic numbers are showing that momentum is slowing. Will that have any impact on the Federal Open Market Committee deliberation next Tuesday? I think it will.

Now the Federal Reserve is less likely to engage in a series of tightening moves as was the case in 1994.

It is now quite possible that the May tightening may be the last one.

Pub Date: 5/18/97

Copyright © 2021, The Baltimore Sun, a Baltimore Sun Media Group publication | Place an Ad