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Economic Outlook

State of the Economy

Alice Rivlin
Senior Fellow, Brookings Institution and Former Vice Chair, U.S. Federal Reserve Board
Thursday, July 1, 2004; 10:00 AM

On Wednesday, the Federal Reserve Board announced the first rate hike in four years. The key interest rate was raised by one-quarter percentage point. How will the decision affect consumers? What is the current state of the economy?

Alice Rivlin, senior fellow at the Brookings Institution, talks about the board's decision on interest rates, the budget deficit and the economic outlook.


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Rivlin is a former vice chair at the Federal Reserve Board and former director at the White House Office of Management and Budget.

Editor's Note: Washingtonpost.com moderators retain editorial control over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions.

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Alice Rivlin: Good morning! I am happy to be here to answer question about the economy, the Federal Reserve, and the federal budget outlook. I haven't done an online interview before, and I am not the world's fastest typist, so bear with me.

The Fed's interest rate increase yesterday surprised no one. They have been telegraphing this move for months. It's certainly the right move now, since the economy is growing strongly, inflation is beginning to tick up, and employment is rising (finally). I expect the Fed to keep raising the short-term rate by a quarter of a percent (or more) every six weeks for the next couple of years.

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New York, N.Y.: Does the Fed have a watershed target which can be defined as a neutral funds rate. For example, would getting the funds rate to the current level of PCE or the GDP deflator a neutral rate or is there a hard target of 3 or 5 percent, etc., that the Fed believes to be neutral?

Follow-up...with the economy apparently stabilized, why does the Fed need to be accommodative?

Alice Rivlin: Remember that "the Fed" is a lot of people (example: 19 members of the FOMC) and hundreds of staff. They don't all think the same thing. I think most economists would estimate neutral monetary policy under current conditions to be around 4 percent.

It shouldn't be so accommodative now--that it's at the point of moving up. But moving fast could be disruptive.

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Knoxville, Tenn.: How will this affect mortgage rates?

Alice Rivlin: Fixed rates have already moved up and may not move much more in the short term. ARMs will rise.

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Washington, D.C.: I was expecting the FOMC to surprise us with a 50-basis-point hike yesterday. Why not move faster to raise rates?

Alice Rivlin: I don't think the Fed wants to surprise people. If inflation accelerates they will move faster, but this move was a strong enough signal for now.

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Washington, D.C.: When do you think public perception of the economy and the job market will start catching up with reality? I'm getting frustrated with others who say that the economy is still in a "recession" or that the job market is bad.

Alice Rivlin: There is a big lag in perceptions. But remember that job growth is pretty recent. We are not nearly back to pre-recession employment levels.

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Washington, D.C.: Alice,
Everyone keeps talking about the "threat" of inflation. But rate hikes aren't that great for the economy either. Is the medicine worse than the disease, considering that the patient doesn't look that sick right now? Not a lot of signs of inflation besides fuel costs.
Thanks for taking my question!

Alice Rivlin: I agree there isn't much threat of inflation, especially if the gas price increases prove temporary. But interest rates are incredibly low. There is no reason to keep stimulating the economy by keeping short-term rates at historic lows. The Fed just wants to get back to "normal."

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Arlington, Va.: Our national savings rate is famously quite low. Can rising interest rates be expected to induce people to save more?

Alice Rivlin: I hope so, but I doubt it. Saving rates have also been low in periods of higher interest rates.

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Arlington, Va.: Will credit card companies use this as an excuse to bump up interest rates?

Alice Rivlin: Yes--they are likely to.

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Silver Spring, Md.: Dr. Rivlin,

Given the bleak federal budget outlook (i.e. mass deficits), there has been considerable debate on whether long-term interest rates rise as a result of this. Which side do come down on? And how does the Federal Reserve factor this in when making monetary policy decisions?

Alice Rivlin: Yes, as the economy returns to full employment I expect long rates to rise. In fact, I'm surprised they haven't risen more already, given the budget outlook.

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Washington, D.C.: Many have said that wage-earners have not benefitted from this recovery, and will continue to be left behind, so to speak. Can you explain why someone would argue that, explain the specific economic factors at work? Obviously there are the tax cuts, but there must be more at work than that.

Alice Rivlin: Wages have begun to move up a little, but so far not much. The high rates of productivity growth have slowed business hiring. High productivity growth ought to benefit wages (and did in the 1990s), but so far this recovery has benefited profits more than wages.

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Washington, D.C.: Do you think that higher mortgage rates will prove to be the pin that bursts a possible bubble in the real estate market? Or do you think that real estate prices are sustainable?

Alice Rivlin: Maybe. I would certainly expect price increases to slow down. But we may not see falling prices (evidence of a bubble) in hot markets like this one.

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Washington, D.C.: It seems these 'new jobs' that are being created aren't really helping to replace what people had lost. We are still seeing teachers getting laid off, the IT sector continues to struggle, and manufacturing jobs are shipping overseas. I'm very curious to know where these new jobs are! It just seems like the sectors of the economy hit by this recession continue to struggle and we are 'told' that new jobs are being created. Can you help me better understand where the new jobs are and if or when the sectors hit the hardest by the recession will recover?

Alice Rivlin: New hiring has been pretty broadly spread. Mostly services, retail, construction, health care and small businesses. Not much yet in manufacturing, which may never recover to the previous peak. State and local governments are still struggling, although their budgets are in better shape than last year. They will be much better off by next year.

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Ellicott City, Md.: As the Fed continues to raise rates to combat inflation, what has historically happened to the national debt? Is there a direct correlation between rates and the national debt.?

Alice Rivlin: The Fed doesn't have much to do with the national debt. That is created by the federal budget deficit, which is huge right now. The deficit will add half a trillion dollars to the national debt this year.

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New York, N.Y.: Don't you think the raise in the mortgage rates is self defeating? There was and still is a great boom in construction of new housing. A lot of people were put to work because of it in that industry (plumbing/electrical, etc.). And so many people were able to purchase properties. Now that the rates are increasing, I think we'll see a great slow down in that area, which may put those people out of work. Then the country is back to higher unemployment. Your opinion. Thanks for taking my question.

Alice Rivlin: If the rates were to rise a lot (as in 1980), you would be right. But remember, at the moment we are talking about very small increases from historically low rates. I don't expect the Fed to overdo it.

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Washington, D.C.: Ms. Rivlin, greeting from a fellow Bryn Mawr graduate. How do you believe this rise in interest rates will affect student loan interest rates, which are currently at their lowest levels in decades? Do you believe that current students will be most affected, or will people who are currently repaying student loans?

Alice Rivlin: I expect student loan rates will be gradually affected and that the burden will fall more on current and future students. But right now we are looking at very small increases.

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Harrisburg, Pa.: I know that Federal Reserve members and staff consider numerous economic indicators in deciding when and how much to change interest rates? How important are some of the different factors, relative to each other? Which are the most important indicators that are watched?

Alice Rivlin: Actually, they watch just about everything, especially consumer prices, unemployment, interest rates of various sorts, and foreign as well as domestic growth rates.

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Pasadena, Calif.: I heard on NPR, a reporter assert that the last time interest rates were raised was 1994. What about the raises prior to the 2000 election over a series of months to thwart the market's "exuberance"?

Isn't the quarter-percent rise a political gift to the right administration, since until more recent alarming inflation data, in part the result of deficit fears, the Fed was committed to "staying the course" until after the election?

Alice Rivlin: I guess even NPR sometimes gets it wrong!

I don't think this move was political. The economy is growing too strongly to justify further stimulus by keeping interest rates this low.

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Arlington, Va.: Everything seems to be looking pretty good right now. How close were we to a really protracted and severe economic downturn?

Alice Rivlin: I think we are a long way from a downturn, conceivably quite a few years. I hope we get back to the low unemployment rates of the late 1990s without a stock market bubble. But there are risks--especially the high budget deficits.

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Washington, D.C.: Will the high deficits, tax cuts and war spending eventually lead to an inflationary cycle as we had in the late 70s?

Alice Rivlin: That's a big risk in my opinion -- one that the Administration and the Congress are not taking seriously enough.

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Columbia, Md.: My wife and I are scheduled to open a Home Equity Line of Credit this Saturday. Is it wise to do so given the fact that the Fed is now raising the prime rate?

Alice Rivlin: The Fed's increase is only a quarter of a point and may not affect your loan much, if at all. The one thing you can probably count on is that rates will be higher a year from now.

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Washington, D.C.: Why are they backing off the economic "gas" pedal when employment hasn't recovered? The core rate of inflation is very modest, only gas and food, which impact working Americans who need more and better jobs, is growing.

Alice Rivlin: They think the recovery has a lot of momentum and expect that job growth will continue and unemployment will come down. The are worried that more gas will overheat the economy down the road.

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New York, NY: the low interest rates were the only thing good about the economy. Huge amounts of home purchases were taking place. Granted, the cost of purchasing has risen quite a bit, but the cost of everything else has increased, i.e. gasoline, electric charges, food, etc. Will the fed take all of this into consideration and lower the mortgage rates again if housing slows down? Thanks for answering.

Alice Rivlin: The Fed will probably keep increasing the short-term rate (the only one they control) slowly until they think they are now longer stimulating the economy. They can't target one particular sector.

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Silver Spring, Md.: How much debt as a percentage of GDP can the country theoretically afford? I was just wondering since the country has the ability to keep rolling over debt indefinitely into the future.

Alice Rivlin: Nobody really knows the answer to that. We had debt higher than GDP at the end of World War II, but the economy was so strong it didn't matter. GDP grew a lot faster than the debt until the 1980s, and the ratio came down. We actually reduced the debt in the 90's and now its going up again--fast. I'm less worried about the ratio than about the fact that a lot of our debt is held by non-Americans who may decide we are not such a great place to put their money if we don't get our deficit down.

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Alice Rivlin: This has been fun, and I am sorry I can't answer all the questions. Thanks for all the great questions, and my apologies to those who submitted questions I didn't get to.

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