The Fed raises its voice

Posted: Thursday, May 18, 2000

The following editorial appeared in today's edition of the Chicago Tribune:

Seeking to be heard over the clamor of buying and selling, the Federal Reserve Board raised its voice Tuesday with a half-percent increase in short-term interest rates - and clearly indicated it is prepared to speak again this summer just as the presidential campaign kicks into high gear.

This was the biggest increase in five years and takes the only interest rates directly controlled by the Fed - the discount rate and federal funds target rate - to levels not seen since the last recession nine years ago.

The action reflects the Fed's growing sense of urgency over inflationary pressures in the economy. The five previous hikes since last June were each one-quarter of 1 percent and seem to have barely registered on the still-buoyant American economy. Why that is baffles some economists who assume - logically - that raising the cost of borrowing money will make people less likely to borrow money. That's basic Econ 101 stuff. But Americans have continued their spending spree, buying cars and houses and stocks with abandon.

There are a couple of reasons higher interest rates haven't cooled things off. The first three of those hikes last summer and fall merely restored three previous emergency rate cuts in the autumn of 1998 as the Asian financial crisis threatened stability around the world.

Then there's the much-discussed ``wealth effect.'' Americans have all but stopped saving money in the traditional sense. But nearly half the population is invested in the stock market and equity gains have made them feel richer and thus less likely to pull back even if interest rates rise. This is true even though stocks in general - and the hot dot-com stocks in particular - are well off their record highs and remain quite volatile.

Productivity increases generated by technology clearly have allowed the overall economy to grow faster, without igniting inflation, than was previously thought possible. And the vibrant U.S. economy continues to attract record foreign investment, which adds more fuel to the fire, as it were.

But with unemployment at a 30-year low, the supply of available workers is about drained and that is - finally - pushing up wages beyond the levels productivity gains would support. That's inflationary and once inflationary expectations gain a toehold, their insidious effects spread like wildfire throughout the economy. Prices go up because workers demand higher wages, higher wages mean still higher prices and the virtuous circle we have enjoyed turns into a vicious cycle.

That's what the Fed is trying to prevent. That's why it's beginning to shout.



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