A Debatable Rate Hike
BATTLE lines have been drawn over the Federal Reserve Board's aggressive 0.75 percentage point hike in interest rates, announced Tuesday.
The rate hike will result immediately in higher borrowing costs for credit card users, home owners with variable rate loans, and companies borrowing from banks. That covers a lot of people who will be unhappy about the hike, the Fed's sixth since Feb. 4 and the largest since May 1981.
The stock market moved up and down Tuesday as investors tried to figure out the implications of the Fed action. (The market volatility surprised some analysts, since a rate hike of between 0.50 and 1 percentage points was widely anticipated.) Bond buyers favor an increase in interest rates that will slow growth and prevent a rise in inflation; others think the hike will lead to recession.
The question is whether the central bank has overstated the threat of inflation. If the Fed slows the economy prematurely, unemployment could rise above its present 5.8 percent, and wages could further stagnate.
Strong criticism has come from such diverse groups as the National Association of Manufacturers and the AFL-CIO. They complain that the economy hasn't yet felt the full effects of the rate hikes earlier this year. That's true, and it's something to be mindful of. Critics with a populist bent say the Fed is only considering wealthy, privileged bond traders.
Opponents of the Fed's action are right to consider the average American. Middle-class families who borrow have to brace themselves for higher costs. The Fed's increase was quickly matched by a 0.75 percent rise in major banks' prime lending rates.
But the Fed does have some solid statistics to back up its claim that the economy is growing quickly, perhaps too quickly to keep inflation in check. Retail sales in October were up more than expected - 1.1 percent, the fifth straight advance. United States factories operated at 84.9 percent of capacity in October, the highest level in almost 15 years. Such steep factory operating rates are considered likely to feed inflation, as companies boost prices on scarce materials and labor costs rise.
The Fed says it is steering the economy toward a ``soft landing'' - slowing it enough to prevent inflation but not so much to trigger a recession. Some analysts say the central bank will have to boost rates again early next year to have the impact that it's after. But the Fed should proceed with caution. It should start thinking hard about what a growing number of people are saying publicly and privately: That the economy has changed to such a significant degree that it has a higher capacity for growth with less threat of inflation, the Fed's greatest foe.