January 21, 1997
Some Fed Officials Call Rate Hike Likely if Inflation Picks Up
By RICHARD W. STEVENSON
ASHINGTON -- Policy-makers at the Federal Reserve say they believe the economy is finely balanced between healthy growth and inflation, and they are almost certain to leave interest rates unchanged when they meet early next month to consider monetary policy for the first time in 1997.
But in interviews and in speeches over the last week, four Federal Reserve governors and several of the regional Federal Reserve Bank presidents suggested that despite the current ideal combination of steady growth, low unemployment and low inflation, they were likely to move swiftly to raise rates if they saw any acceleration in wages or prices later in the year.
"It's like being at the top of a mountain," Laurence H. Meyer, who was named to the Fed's board of governors by President Clinton last year, said in a speech last week. "There is an exhilaration from getting there and the view is great, but all paths are downhill."
The Fed officials outlined a series of issues that they said could influence the economy this year, from rising levels of consumer debt to the possibility of an agreement to balance the federal budget to whether reductions in health care inflation can be sustained.
And they said that reading the economy's direction was becoming more complex as old assumptions about the relationship between growth, unemployment and inflation are called into question, making policy decisions that much more difficult.
Until last year, for example, it was an article of economic faith that if unemployment remained below 6 percent for any length of time while the economy continued to grow, the inevitable result would be inflation. Instead, unemployment has remained below 5.5 percent, and while wages have been rising moderately, inflation has remained dormant.
On Wall Street, the emerging consensus is that the Fed is growing increasingly wary of rising wages, and will raise rates, perhaps as early as March, in a pre-emptive strike against inflation.
"In the absence of a full-scale retreat in demand growth in the early months of 1997, officials are likely to conclude that higher underlying inflation may be unavoidable without the insurance of tighter policy," Salomon Brothers told clients in a report Friday.
Fed Chairman Alan Greenspan, whose views on monetary policy remain decisive within the institution, is to testify Tuesday before the Senate Budget Committee.
Including Greenspan, there are seven seats on the Fed's board of governors, although two seats are currently vacant. All the governors plus five of the presidents of the regional Federal Reserve banks get a vote on monetary policy.
Fed officials offered the following analyses of the economy last week:
ALICE RIVLIN
Mrs. Rivlin, who was the White House budget chief before being named vice chairman of the Fed by Clinton last year, said there were opportunities in the tight labor markets.
"For the long-run future it's very important to keep the labor markets as tight as possible without accelerating inflation," she said in an interview. "People get more training. They get promoted into better jobs. There's an incentive to hire people who might otherwise not get hired."
Indeed, she said, it was particularly important to keep unemployment rates low as the nation begins to carry out welfare reform, a process that will require moving millions of low-skilled benefit recipients into jobs in coming years.
To succeed in that goal will require stamping out inflationary pressures before they take root, she said, so the country can avoid the traditional business cycle of high interest rates followed by recession.
"Welfare reform will be difficult at best, and impossible in a recession," she said.
On the plus side for the economy, she said, the outlook for Congress and the White House for reaching agreement on a balanced budget is good.
To help do so, she said, Congress could temporarily reduce the cost-of-living index used to set Social Security and other benefit payments by half a percentage point or so below the Consumer Price Index, which is widely judged to overstate inflation, while the Bureau of Labor Statistics works on a long-range fix.
LAURENCE H. MEYER
In looking at how inflation has remained relatively dormant in the face of low unemployment, Meyer, who was appointed to the Fed last year and is one of the nation's foremost economic forecasters, starts with what he called "a series of favorable supply shocks."
By that he means falling prices in several categories that are not usually included in the traditional models of the trade-off between inflation and unemployment. Health care inflation is declining as companies move employees into managed care programs, reducing corporate benefit costs, holding down overall compensation and lessening pressure on companies to raise prices. Computer prices are declining sharply. And import prices declined last year as the dollar strengthened.
Because those developments are likely to be temporary, Meyer said, there may be "some gradual increase in core inflation this year," although any increase could be "more than offset in 1997 by a slowing of the increase in food prices and a partial reversal of the recent increase in energy prices."
Meyer said there was some evidence that concern about job security was tempering demands for wage increases, helping to keep the traditional wage-price spiral from being activated. But he offered an alternative view based on the idea that the inability of companies to raise prices has altered the wage-price dynamic.
"The point of departure is the perceived inability of firms to pass forward increases in prices," Meyer said in a speech last Thursday.
"That dictates an obsession by firms with containing costs. That means bargaining aggressively to avoid increases in wage costs, intensive efforts to offset any wage increases with productivity gains, and the necessity of absorbing in profit margins increases in costs that cannot be offset."
And why are companies so constrained in raising prices?
"The absence of pricing leverage may simply reflect the fact that product markets are not tight, compared to labor markets," Meyer said.
"There may be some excess demand in labor markets, but the effect on wages and prices is being offset for the moment by favorable supply shocks. On the other hand, capacity utilization rates show no signs of excess demand in product markets."
SUSAN M. PHILLIPS
"One worrying area is consumer debt," said Ms. Phillips, who was appointed by President George Bush in 1991. "Consumers have been financing a lot of their purchases with credit, especially credit cards. More recently, banks appear to be switching more to home equity-type loans -- they want more collateral."
Although consumer-debt delinquencies have been rising, employment and consumer confidence remain strong, and many consumers feel financially secure in part because of the rapid increase of any investments they have in the stock market, she said.
But even if high levels of consumer debt do not become a big problem, they are likely to put a crimp into spending plans by limiting the amount of additional debt people can afford to take on, she said.
"Probably all they can do is continue to spend at their income level," Ms. Phillips said.
EDWARD W. KELLEY JR.
Kelley, who has served as a Fed governor since 1987, said it was unclear to him whether the current, benign economic conditions indicated a fundamental change in the way the economy works or whether the ongoing expansion, now almost six years old, is just part of an extended business cycle.
"I have no notion whatsoever that the business cycle has been extinguished," he said in an interview. "Tempered? That's a more interesting question. We had a long expansion through the 1980s. Then we had a rather brief and not very severe recession that might not even have happened without the gulf war interlude. Now we're into another long expansion.
"You could say this country has been in an expansion with only a brief hiatus since 1982. There is a strength and a vitality in this economy that is not immediately apparent in the statistics."
Other Places of Interest on the WebFederal Reserve Board Biography of Alice M. Rivlin Biography of Edward W. Kelley, Jr. Biography of Susan M. Phillips Biography of Laurence H. Meyer
Copyright 1997 The New York Times Company
