WILL the Federal Reserve be a post-election economic party-pooper?
Both new members of Congress and successful incumbents will be watching as the Federal Reserve begins the process of slowing the economy with a mid-November interest rate hike. Although the hike will probably cause much groaning in Washington, many economists say it is essential.
The Clinton administration welcomes continued signs of strong economic growth, a low jobless rate, and low inflation as proof that its economic policies are working. Political analysts speculate that the latest numbers might provide a limited lift for Democrats in midterm elections.
But despite the positive spin, economists say inflation worries will force the Federal Reserve to act, which means higher home mortgage and auto loan rates.
``There are very clear and convincing signs the economy has not slowed down from the past rate hikes,'' says Lyle Gramley, a consulting economist with the Mortgage Bankers Association in Washington. Mr. Gramley, a former Fed governor, says he expects the nation's central bank to raise interest rates by 1/2 a percent after its Nov. 15 Open Market Committee meeting.
The rate hike became more likely after the Commerce Department reported Friday that preliminary data shows the nation's gross domestic product (GDP) grew at a faster-than-forecast 3.4 percent annual rate in the third quarter of 1994. This is a slight reduction from the 4.1 percent annual growth rate in the second quarter. Most economists say the sustainable annual rate of growth for the economy is closer to 2.5 percent.
Though it is not likely the rate rise will immediately slow the economy, Gramley says he doubts that the Fed will raise rates by a full percentage point. ``That would send the message that there is something really worrisome down the pipeline and could rock the markets,'' he explains. He says he expects the Fed to crank rates up another half a percent in mid-December.
Initially, any interest rate hikes will ripple through to the housing and auto markets. On a 30-year, $100,000 mortgage, a half percent rise would increase monthly payments by $36 a month, or $12,960 for the life of the mortgage. Over time, however, the additional cost of money impacts most economic activities.
The third-quarter numbers ``almost guarantee'' a rate rise in November, says William Sullivan, a senior economist at Dean Witter Reynolds. However, he adds that there are still some ``chinks in the recovery armor,'' such as a slowdown in construction and capital spending and rising inventories, that may be a drag on the economy next year.
Some economists argue there is no need to raise rates. ``I don't believe a strong economy leads to inflation, the same way I don't think a weak economy leads to deflation,'' says Charles Plosser, dean of the William Simon Graduate School of Business at the University of Rochester in Rochester, N.Y.
Professor Plosser says the nation's monetary policy is now correct. ``The Fed needs to focus on sustainable monetary policy compatible with low inflation, not on quarter-to-quarter changes.''
The GDP statistics indicate a 1.6 percent inflation rate in the third quarter.
``There is not enough inflation to justify panic on the Fed's part,'' says Gary Shoesmith, who teaches economics at Wake Forest University in Winston-Salem, N.C. Professor Shoesmith, nonetheless, says he expects the Fed to raise interest rates in mid-November.
Even with a rate hike by the Fed, the United States economy will grow at about the 4 percent range through 1995, says Gail Fosler, chief economist for the Conference Board, a New York-based business organization. Higher rates, she notes, have merely kept the economy from accelerating.
There are plenty of signs the economy is in high gear:
* Government reports indicate that in September, factories ran at 84.6 percent of capacity, which economists consider close to full capacity. The high activity is causing serious delivery delays, according to the National Association of Purchasing Managers.
* Unemployment in September moved down to 5.9 percent, regarded as close to full employment. Some economists say the labor market has reached a plateau, but labor economist Ken Goldstein of the Conference Board predicts that hiring will pick up in the last months of the year and into the first half of 1995. ``There are already some isolated instances of labor shortages,'' he says.
* Raw material prices, such as steel, textiles, leather, industrial chemicals, paper, and plywood, are rising. Some of the prices are now getting passed to wholesalers. The core intermediate producer price index in September was up 3.5 percent compared with 1.5 percent in 1993.
``The key question is will the price rises get through to wages,'' says Ian Borsook of Merrill Lynch & Co. ``If wages don't rise, inflation will be kept in check.''