Fed's rate hike seen as `mild' but necessary move to stem inflation

WHEN Alan Greenspan took over at the Federal Reserve System last month, many market watchers figured he would demonstrate his inflation-fighting commitment by tightening credit. It was seen as a necessary test of his manliness, like some African tribal youth spearing a lion in olden days.

Was Greenspan proving his ``monetary virility'' Friday when the Fed boosted the discount rate - the interest it charges on loans to commercial banks - from 5.5 percent to 6 percent?

Not really, says Lawrence A. Kudlow, chief economist with Bear, Stearns & Co. He figures the Fed was forced to move to stem a potentially inflationary further decline in the price of the dollar. The dollar slipped to about 141 Japanese yen or 1.7950 Deutschemark, close to the lows of last May. Bond and stock prices were falling too. And interest rates were rising.

The Fed's increase in the discount rate was, in Mr. Kudlow's view, a ``mild'' measure. It was not a spear-throwing move. Kudlow doubts it will slow the economy noticeably, even though the commercial banks moved quickly to make a similar upward boost in the interest they charge their best customers.

Indeed, Kudlow suspects the Fed will have to tighten money more forcefully later later this month or next month.


One reason is the pickup in the pace of the economy. Kudlow talks of a handsome real 4.5 percent annual growth rate this fall. Also, consumer prices have risen at a 5 percent average rate this year.

Manufacturers Hanover Trust Company economists point out that industrial commodity prices are up better than 35 percent in the past 12 months. They worry about workers soon playing ``catch-up'' on wages.

The growth of the nation's money supply has slowed dramatically in the last six months. But Kudlow says he doesn't lose any sleep over this trend, though in the past it has often been followed by a slowdown in business activity. He figures the monetary data is distorted by a technical factor - tax-related borrowing decisions. Moreover, the velocity of money - how fast it is turned over - has started to grow again. That means more growth with less money. Because inflation and interest rates are up somewhat, people are not holding onto money so long. They are investing or spending it.

However, the growth of what economists call ``high-powered money,'' alias the monetary base or Reserve Bank credit, shows only mild restraint. This form of ``money'' - controlled directly by the Fed - is still growing at historically high rates.

Greenspan has chaired one meeting of the Fed's policy-making Open Market Committee (FOMC) in August. Kudlow believes Greenspan will be devoting considerable effort to reaching a policy consensus within the seven-member Federal Reserve Board and the 12-person FOMC. He will want to avoid the public contentiousness that troubled the system during the last few years of the chairmanship of his predecessor, Paul A. Volcker. Though the Fed chairman has more influence on these two committees than his one vote would indicate, any successful chairman must persuade his colleagues to go along with his views.

Friday's careful move shows the Fed, under its new chairman, can make quick decisions, just as it has in the past.

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