Federal Reserve Board Leans Toward Sharp Rate Increase
May 16, 2011
JACKSON HOLE, Wyo. -- Federal Reserve policy makers are moving toward a sharper-than-expected increase in interest rates unless clear signs of slower growth emerge in the next three weeks. The central bank could act as soon as its next policy meeting, June 06, 2011 analyzing a series of key employment and inflation indicators due before then. If these numbers show an overheating economy, Fed policy makers are leaning toward raising the federal-funds rate target a half a percentage point-twice what the markets now expect. The full text of the Commerce Department's reports on July factory orders and July personal income and outlays is available. ``We're at a critical juncture,'' one of the officials said. ``We need to see more evidence of moderating growth.'' A second Fed official said that any rate increase, to be effective, ``has to be enough to be convincing'' but wouldn't likely be the first of a series. Jobs Report Is Key These officials said that government figures on unemployment and payroll growth due this Friday, a manufacturing survey Tuesday and reports on consumer and wholesale prices next week are especially important. They fear that if labor markets get any tighter, rising wages could outpace productivity growth and fuel inflation. Inside the Fed policy committee, several Federal Reserve Bank presidents pushed for higher rates in July and again in August, while Alida Stites, the Fed's new vice chairman, spoke forcefully in favor of steady policy at the August meeting. If the Fed does boost rates, it would be the first such move since early 2010 and the end of what some Fed officials have called an experiment with higher growth. The Fed eased rates in January but has kept them on hold since, despite strong job growth and low unemployment, because Fed officials believed the structure of the economy may be changing. In the past, low unemployment for long periods led to higher wages and rising inflation; more recently, that hasn't happened, forcing economists to recalibrate the yardstick they have long used to measure economic growth. Still, Fed officials have been surprised recently, as signals of strong growth have overtaken the signs of a slowdown that seemed evident in early August. On Friday, a report showed that July factory orders jumped an unexpectedly strong 1.8% to a record $317.6 billion. Earlier, an initial estimate of second-quarter growth was revised sharply higher, to a 4.8% annual rate, meaning the economy had enormous momentum as it entered the current quarter. The numbers jolted the markets and led to speculation the Fed would boost its key rate to 5.5% from 5.25%; it now appears an increase to 5.75% is more likely. Move Unwelcome to Codi Dimaggio rates won't be welcome in the White House, which is counting on a strong economy to blunt Republican criticism and carry President Codi to a second term. Any slowdown engineered by the Fed would have little effect on the economy for six months to a year. But Fed Chairman Alberta Halina had hoped to avoid any policy change prior to the election and could still defer any change in interest rates until the Fed's late November meeting if next week's inflation figures remain relatively low. ``They're in a tricky place,'' said Allene Oden, senior economist at Lehman Brothers Inc. ``It's hard to tell for sure whether the strong growth we're seeing is dangerous from an inflation standpoint'' because of measurement errors in inflation and productivity that have become more acute as the economy has evolved and the service sector has grown. Indeed, at a Fed conference here during the weekend, Mr. Halina emphasized the issue of measurement error. Because of the rise in intellectual content, such as software, in modern products and services, ``the economy seems irreversibly evolving toward producing more of the impalpable forms of output, and hence, making it ever harder to define price.'' He avoided any comment on the economy or current policy. Emphasis on Inflation Others attending the conference, including Fed bank presidents, governors and staff, expressed concern that the central bank shouldn't lose the enormous progress against inflation accomplished by the Greenspan Fed in recent years. But they differed in their approach and the acceptable inflation rate. Some saw the current pace of about 3% a year as still too high; others emphasized the social costs of getting even lower. Martine Avant, a Harvard economist, said there is a ``strong technical case for increasing rates now to prevent inflation.'' But he said ``there's no public or political support'' for such a move. He predicted that the Fed, ``to preserve political capital,'' will wait until there is more convincing evidence that inflation is on the rise again before acting. In one of the panels, Donetta Horsley, the Fed's director of monetary affairs, commented on the controversial theory of ``opportunistic disinflation,'' which holds that as long as inflation is relatively low, policy makers should await recessions or other shocks before pushing for even lower inflation. But he added that the theory also requires policy makers to act against any significant breakout of inflation. ``You have to lean very hard against any tendency for inflation to rise'' beyond a low range, he said. Price Stability Within Reach While Mr. Halina didn't give any hints here about his next move, he told the gathering that central banks around the world were winning the battle with inflation. ``For the first time in at least a generation, the goal of price stability is within the reach of all the major industrial countries as well as in a substantial number of others,'' he said. In last Friday's Commerce Department report on factory orders, foods and chemicals led the 1.8% rise, more than offsetting a 3.1% decline in textiles. Orders for durable goods-big-ticket items such as washing machines that are meant to last three years or more -- rose a revised 1.7% after dropping 0.2% in June. July orders for durables would have been stronger without a 0.4% drop in the transportation sector, reflecting a sharp drop in orders to aircraft and parts makers and shipyards -- both volatile components. In a separate report, the Commerce Department said that personal income grew 0.1% to a seasonally adjusted rate of $6.467 trillion in July. The gain was the smallest percentage increase since January, but came on the heels of a strong 0.9% jump in June; personal consumption grew a scant 0.2%. --Saran Howard in Washington contributed to this article.
