Hot Economy Stokes Interest Rate Fears

The continued growth of the U.S. economy--at a pace far faster than the Federal Reserve would like to see--has rekindled fears that the central bank will see a need to raise interest rates to slow the expansion down.

The apprehension of some analysts was evident Saturday in interviews at a weekend symposium here attended by top Federal Reserve policymakers and private analysts from across the nation.

Although the interest rate issue is not on the agenda, the retreat comes just after the Commerce Department reported that the economy grew at a revised 3.6% annual rate last quarter, rather than the 2.2% previously estimated.

The statistical revision appeared to put the Fed in a bind: Only four weeks ago, its policymaking Federal Open Market Committee passed up an opportunity to raise interest rates--largely on the premise that the growth rate would slow before long.

A week and a half later, Fed Chairman Alan Greenspan proclaimed at a congressional hearing that everything seemed to be right on track, hinting that the Fed was unlikely to raise rates soon--possibly not until mid-1998.

But now, some experts are worried that the new figures may push the Fed back to the kind of red-alert status that it adopted last spring, looking for--and moving quickly to quell--any signs of renewed inflation.

A number of analysts fear that unless the economy slows to a growth rate of between 2% and 2.5%, it could spawn more labor shortages and intensify pressure for higher wage increases. That, in turn, could spark higher prices.

While there has been no indication here that a rate hike is imminent, there have been hints that some FOMC members may once more be ready to launch a “preemptive strike” against inflation, as the Fed did in March.

Although most private analysts saw little sign then that inflation was rising, the Fed, in a show of force, boosted the interest that banks charge on overnight loans to one another to 5.5%--up from 5.25%.

Private Fed-watchers attending the conference predict that the Fed will find enough evidence of possible inflation to boost rates modestly again before year-end--possibly as early as the FOMC meeting scheduled for Nov. 12.

“Hopes for the slowdown that Fed policymakers assumed would be in place by now disappeared with last week’s figures,” said Allen Sinai, chief economist at Primark Decision Economics Ltd.

“It won’t take much” in the way of signs of renewed inflation to prod them into raising interest rates again, Sinai said during a break in the conference, which is sponsored by the Federal Reserve Bank of Kansas City.

Roger E. Brinner, chief economist at DRI/McGraw-Hill, a forecasting firm, agrees. Moreover, he predicts that a modest quarter-point rise, like the one the Fed ordered in March, may not be enough, and a second rate hike may be needed.

Despite such pessimistic forecasts, however, there has been no indication here that Fed policymakers are feeling the same sense of urgency about the new growth figures.

Although the economy has not slowed as Fed officials hoped, last week’s statistics only reflected conditions at the start of the third quarter. The economy still could slow, easing pressure for a rate hike.

Moreover, for all the rapid growth, the statistics still show no signs of new inflation pressures, either in the form of increases in wages or prices. Wholesale prices actually have declined all year.

While the Fed may well move quickly if it sees signs that wage increases are beginning to speed up, as policymakers feared in March, it is reluctant to invite criticism by raising rates before any firm evidence is in.

Congress reacted angrily after the March rate hike, on grounds that the central bank had little to justify its tightening. The Fed contended that it was only launching a “preemptive” strike to ward off further inflation.

Henry Kaufman, a veteran Wall Street Fed-watcher, points out that both conservative Republicans and liberal Democrats are dead-set against a further rise in interest rates--a formidable force for the Fed to contend with.

At the same time, middle-income Americans, now heavily invested in the stock market, are loath to see any new jolts. As a result, “there’s not enough broad political support for raising rates,” Kaufman said.

Even so, Fed-watchers warn that if central bank policymakers wait too long, they could set off more turmoil in the financial markets, which get nervous when they think the Fed is not doing enough to combat inflation.

“It’s a doomsday scenario,” said David M. Jones, a Fed-watcher at Aubrey G. Lanston & Co. “If inflation psychology returns, there could be a crash, which would tie the Fed’s hands. It couldn’t raise rates then if it had to.”

Jones and other analysts say Fed policymakers will be looking at two questions during the next few weeks: Is consumer spending rebounding--or finally slowing--and is the overall growth rate moderating as they have hoped?

The public may get some hint of Fed officials’ feelings in public speeches and congressional testimony. The FOMC meets again on Sept. 30. Whatever action it takes may shed some light on what lies ahead for coming months.

But for now, the central bank is facing a frustrating truism: For government policymakers, it often is easier to make decisions in the face of a crisis than it is to manage a successful economy.