Share this story
Close X
Switch to Desktop Site

Defying logic and gravity, economy chugs onward

Federal Reserve is likely to leave interest rates unchanged when it

The continued robust health of the American economy - in the face of myriad reasons it should begin to flag - almost seems to defy explanation.

Investors are undaunted, despite warnings that the stock market is overvalued. Inflation, the old bugaboo, has not reappeared, despite worry that a tight labor market would reignite it. Neither has economic fragility abroad had a decisively negative effect at home. Consumers keep on buying.

About these ads

Economists will admit they don't completely understand how the US economy remains so buoyant, but their maxim these days seems to be: Why mess with success?

That's the likely approach the Federal Reserve Board will take today in Washington, when it meets to decide whether to put the brakes on the economy by raising interest rates.

The Fed has been "willing to say that the economy is working in a way that it has not worked before - and that we, in fact, don't fully understand," says William McDonough, president of the New York Federal Reserve Bank. "But we are going to let it happen."

Indeed, most economists do not expect the Fed to raise short-term interest rates for the remainder of the year.

No braking for war

Even the war in Kosovo isn't likely to jostle the economy enough to alter the Fed's course. (See story, page 3.) In relation to the nearly $8.7 trillion US economy, the costs of war are minor.

"There isn't any reason to think it is going to have any impact on our lives," says Cynthia Latta, an economist with Standard & Poor's DRI, a consulting firm in Lexington, Mass.

About these ads

Yet some analysts do see some scenarios that could lead to a small interest-rate hike later this year.

In particular, higher oil prices, resulting from an agreement last week by the members of the Organization of Petroleum Exporting Countries to cut production, will mean that motorists will pay more at the pump, says Ellen Gaske, an economist with Prudential Economics in Newark, N.J. That could create a spike in inflation - rousing the Fed's concerns.

In fact, she notes, if energy prices were excluded, consumer prices rose about 2.6 percent last year, rather than the 1.6 percent recorded by the government.

She predicts all this will lead the Fed to raise the rate for overnight loans between banks by 0.25 percentage points to 5 percent.

Other analysts say prices of goods and services could be pushed higher by a Japanese economic recovery.

Recovery abroad

The Bank of Japan has been flooding its commercial banks with reserves in the hope of lifting the economy. If successful, this would boost US exports. Then, as Japanese consumers start demanding more goods, prices would tick upward, says Paul Kasriel, an analyst at Northern Trust Co.

"Stronger foreign demand on top of already strong domestic demand might cause the US economy to boil over," Mr. Kasriel warns. That would force the Fed to act, he adds.

Another risk he sees is that the recent rapid growth in the US money supply - the fuel for economic growth - will stimulate business activity.

"We could have a genuine boom on our hands in 1999, which could prompt a Fed tightening [of interest rates] at either the June 30 [policymakers'] meeting or the Aug. 24 one - or both," he cautions.

The mystery economy

For now, though, economists have attempted to explain the mystery of the "new economy" in any number of ways. Many see technological advances as boosting productivity of American workers, helping the economy to expand without causing much inflation.

Whatever the reason, US inflation is low and the increases in wage costs are decelerating despite a low unemployment rate.

If the majority of Fed policymakers were greatly concerned by the expanding money supply, they might be more inclined to raise interest rates. But in general, Fed officials pay little attention to the money supply, says Mickey Levy, chief economist at BankAmerica.

That's a formula for no Fed action today, says Mr. Levy. "The Fed will remain on hold."

And according to a Bloomberg News poll, analysts at 30 Wall Street bond firms agree. That means no brakes on the American economy's enigmatic expansion, eight years old this month.

Follow Stories Like This
Get the Monitor stories you care about delivered to your inbox.