Rates Likely to Rise in Small Steps

Fed Governor Says Inflation Should Stay Low Into '05

The Federal Reserve, which has signaled that it will soon increase interest rates, probably will do so in a series of small steps over many months or even a few years, one of the central bank's policymakers said yesterday.

A variety of forces, including small increases in interest rates, should keep inflation very low, "in the zone of price stability," for the rest of this year and into next year, Fed Governor Ben S. Bernanke said in a speech yesterday.

However, the pace and size of the increases could vary depending on the strength of the economic expansion, particularly the behavior of inflation and the labor market, he said at an event in Seattle, according to a text released in Washington.

Bernanke's remarks provided some guidance on what the Fed's top policymaking committee meant this month when it said its target for a key short-term rate, the federal funds rate, could be lifted "at a pace that is likely to be measured."

Analysts and investors interpreted that to mean that the Fed was preparing to raise the target, which has been 1 percent since last June. The strong April employment report and other recent economic indicators convinced many observers that the Fed will act at its next meeting, at the end of June, to raise the target by one-quarter percentage point, to 1.25 percent.

Economists remain divided over what they think the Fed will do after that meeting. Some predicted a few more small increases this year and others said the central bank is already behind the curve and will have to move more aggressively to rein in rising inflation.

"It appears likely that this normalization [of interest rates] can proceed gradually," Bernanke said yesterday, defining "gradualism" as adjusting rates "incrementally, in a series of small or moderate steps in the same direction."

As examples of "gradualism," he cited the four instances in the past 15 years when the Fed has raised or lowered its target, which influences many long-term rates determined by the markets. Lifting the target raises borrowing costs, curbing spending, and generally slows the economy's rate of growth. Lowering the target does the reverse.

In those four cases, the process of raising or lowering the target was accomplished in a series of small steps, usually a change of a quarter or half a percentage point, over periods that ranged from 11 months to more than three years.

Bernanke's remarks implied that financial markets should not worry about a rapid increase rates.