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Yes, higher interest rates do have an effect

While some wonder if Fed moves can slow the red-hot economy, others say they're working - and may go too far.

By David R. FrancisStaff writer of The Christian Science Monitor / March 29, 2000

The Federal Reserve will succeed - in fact it may have already succeeded - in braking what it sees as a runaway US economy.

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True, a common view lately is that the Fed's moves to raise interest rates are doing little to slow an economy that has been moving like a photon down a fiber-optic cable.

Even on the Fed's policymaking committee, there has been talk that the next rate hike may need to be by half a percentage point, not the modest quarter-point moves the agency favored of late.

But recent government statistics suggest that the monetary tightening is already having its intended effect. Indeed, some economists have concerns that an overzealous Fed or other factors could actually push the economy into recession.

Already, higher interest rates are biting into many Americans' pocketbooks. A bigger downshift in the economy would reach broadly into everything from jobs and home values to the health of financial markets - even the outcome of this fall's presidential election.

"Growth is slowing as sure as spring is arriving," says Gordon Richards, chief economist of the National Association of Manufacturing in Washington.

Last Friday, the Commerce Department reported a decided drop in new orders for durable goods, such as refrigerators, in February. That was the second consecutive monthly decline. Other indicators last month of a slowdown include smaller gains in industrial output and fewer new jobs.

The Fed's intention is to slow business activity only modestly - enough to avoid any buildup of price inflation. And so far, most economists expect this kind of "soft landing" for the bustling economy. The Fed began raising rates last summer, and typically, it takes nine months or so for such moves to be seen in statistics.

The nation's output of goods and services, or gross domestic product, grew 4 percent after inflation in 1999. The Fed sees a roughly 3 percent pace as sustainable.

The sense of urgency - including talk of half-point rate increases - stems in part from the economy's bristling pace in the fourth quarter of 1999, when it grew at a 6.9 percent annual rate.

Clamping on the brakes hard would cause a recession - an actual drop in national output over six months or more.

But even the Fed's "drip, drip, drip" restraint, if it goes too long, could turn a slowdown into a bad slump, say Mr. Richards and other economists such as James Galbraith of the University of Texas, Austin.

Here's how such a "hard landing" could affect all jobs, family incomes, corporations, and the election:

Jobs. The less-skilled and less-educated will have a tougher time finding work. And they would bear the brunt of layoffs.

Also hurt will be blacks and Hispanics, single mothers trying to move off welfare, and other low-income individuals.

"There is no reason to think that the rule of last-hired, first-fired won't prevail when we hit a downturn," says Jared Bernstein, an economist at the Economic Policy Institute, a liberal think tank in Washington.

Families. Households, especially those in the middle- to lower-middle income range, would find their available spending money shrunk by higher interest charges on car loans, credit-card debts, and home mortgages with variable interest rates. (Those low on the income ladder have less access to credit - and a smaller interest burden.)