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As an interest-rate hike looms, the Fed must find a way to spur growth but avoid inflation, Newsday, 6/27/06 BY RANDI F. MARSHALLNewsday Staff Writer June 27, 2006 A CRUCIAL BALANCE As an interest-rate hike looms, the Fed must find a way to spur growth but avoid inflation. A 17th consecutive interest rate increase by the Federal Reserve at its meeting this week - almost universally expected - would leave economists, policymakers and consumers to wonder: Is the Fed's Open Market Committee going too far? Will the committee push the economy into a slowdown? Will it have to reverse course and lower rates again? Or, is another rate hike exactly the right move? Are the committee's members finding the perfect stopping point for rate hikes and striking the perfect balance between economic growth and inflation? The answers, of course, are anyone's guess, for now. But the two-day meeting, beginning tomorrow, could be the committee's most important since the summer of 2004, when interest rate hikes began, said Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pa. "Raising interest rates from such a low level [1 percent] in a relatively good economy is easy," Zandi added. "Tightening monetary policy now, with rates as high as they are, is much trickier and risks putting the economy under pressure that will be hard for it to bear. "Indeed, the Fed is in a tough position as it approaches this week's meeting. Inflation continues to be a legitimate concern, as the core rate rose at an annual clip of 2.4 percent last month, and the overall rate, including food and energy costs, increased 4.2 percent for the year, according to the U.S. Bureau of Labor Statistics. But further increases in short-term interest rates could lead the economy to slow significantly, potentially weakening both wage and job growth, and consumer spending, which may decline as the cost of borrowing grows. "We're not talking about a recession, we're talking about a soft landing, like in 1995 ... " said Alan Levinson, the chief economist at T. Rowe Price, a national investment firm. "The economy is still fundamentally healthy in most respects. "But there's particular concern about the housing sector, as long-term mortgage rates will rise along with the short-term ones. That'll affect consumers' ability to use the equity from their homes for other big ticket purchases. "I'm hoping this is the last of it," said Bob Moulton, president of Americana Mortgage Group in Manhasset. "Sixteen times is enough - 17 times definitely is." For now, though, the Fed's priority is battling rising prices. Part of that effort, Zandi noted, is to restore credibility and reinforce the Fed's role as an inflation-fighter. That's why most experts are predicting the Fed will probably raise rates by a quarter-point this week - and some say even once more in August. "They should be willing to go past neutral and make sure they've reversed the underpinnings of any sustained inflation," Levinson said. But there's a definite possibility that the Fed will overshoot. "The danger is if there are one or two extra tightenings beyond what's needed, the Fed has to turn and do an about face," said Robert T. McGee, who chairs the Economic Advisory Committee for the American Bankers Association, which met last week to discuss the upcoming Fed meeting. "We think that's probably likely." McGee, the chief economist at U.S. Trust Co. in Manhattan, noted that the Fed's previous rate hikes haven't yet worked themselves through the economy - and that they alone could eventually slow inflation. But he added that the effects of further rate hikes now or in August won't be clear for another six to nine months. "I think we're going to look back at the end of the year and say it's a good thing the Fed kept raising interest rates, because otherwise, we'd really have a problem [with inflation]," said Hofstra University economics professor Irwin Kellner, the chief economist for North Fork Bank. Some experts aren't willing to discount the possibility that there are serious economic consequences no matter what the Fed does. "Either way, they risk a recession," said Pearl Kamer, the chief economist of the Long Island Association, the region's largest business group. "The question is which would be more damaging: one caused by runaway inflation or one caused by inadequate demand [for products and services]? ... I don't think [the Fed] has good choices right now." Fighting inflation The Fed changes interest rates in an effort to slow inflation. Figures from the consumer price index (CPI) below represent the annual overall inflation rate nationwide for the 12 months ending in May. Interest Rate CPI 1996 5.25% '96-'97 2.9% 1997 5.5% '97-'98 2.2% 1998 5.5% '98-'99 1.7% 1999 4.75% '99-'00 2.1% 2000 6.5% '00-'01 3.2% 2001 3.75% '01-'02 3.6% 2002 1.75% '02-'03 1.2% 2003 2.1% '03-'04 1% 2004 3.1% '04-'05 1% rising 2005 2.8% '05-'06 2.8% 2006 5% '06 4.2%
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