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The Federal Reserve and the Economy
With Post reporter John M. Berry

Monday, January 31, 2000 at 1 p.m. EST

Are you interested in the inner workings of the Federal Reserve and whether the group is likely to announce an interest rate increase on Wednesday?

John M. Berry has covered the economy and the Federal Reserve for 30 years, the last 21 with The Post. His work is closely followed on Wall Street for insights into the thinking of Fed officials, many of whom he interviews on a regular basis.

Berry will take your questions and comments at 1 p.m. Monday.

Submit questions early.

Erhart Heights, MD: It is widely expected that The Fed will raise rates this week but as an economist I disagree. Why is that unemployment can be level, inflation low, the CPI stable, the scrotum index flat, and consumer sentiment be high, yet Greenspan still hints at raising rates? I don't understand? -Mike

John M. Berry: Greenspan and his colleagues say they are concentrating on trying to preemptive--that is, raising rates now in order to slow economic growth, which if it continues at its recent pace, they fear will eventually trigger more inflation. Obviously there is plenty of room for disagreement on the both the basic assumption and on the timing of any rate increase.

Washington, D.C.: Some interest rate hike on Wednesday appears to be a given. Having said that, what would be possible signs that would hold off future rate hikes at subsequent meetings?

John M. Berry: Essentially the Fed would like to see a slower rate of economic growth that would relieve some of the pressure on the nation's very tight labor markets. The housing sector of the economy is slowing modestly, and in the fourth quarter so did business investment.But consumer spending is still increasing very rapidly. Most of all, a slower trend in consumer spending is what they are after, so watch those numbers closely. At the same time, continued evidence that consumer prices, excluding food and energy, are not accelerating would also be a factor affecting the timing and size of future increases.

Arlington, VA: I have heard that if the price of a barrel of crude oil hits $40.00 per barrel or higher, we could be in for a big jump in inflation, perhaps a recession. What do you think

John M. Berry: Certainly that would put some added pressure on prices. But energy plays a relatively much smaller role in the economy than it did during the 1970s and early 1980s when oil price increases pushed inflation to record levels. Recessions followed when the Fed raised interest rates sharply to wring the inflation out of the economy. $40 oil would mean further increases in gasoline prices. However, we are already at about $27, so a move to $40 would be a little less that what has taken place over the past year.

Camano Island, WA: john, it looks to me that the boom is at least partly related to the stock market performance. For the Fed to cool the boom it must bring down the stockmarket and that can only be done by moving more aggressively and raise rates by half a point from now on. Do you agree? Rimmer de Vries

John M. Berry: Hi, Rimmer. Well, I'm not in the business of giving the Fed advice on how much rates should rise, thank goodness. I'll leave that to you economists. But recall that Greenspan has said on several occasions that he does not think the Fed should try to target particular levels of asset values, including stock prices, because it's impossible to tell there's a bubble until after the fact. Instead, he said last summer, that the central bank should concentrate on keeping inflation low so that if there is a stock bubble and it bursts and hurts the real economy, then the Fed will have the leeway to step in a limit the negative impact. With core inflation still well behaved, I would be surprised if Greenspan embarks on a series of half point increases.

Tahlequah, OK: Will tax cuts and a pay down in the national debt overstimulate the economy? How will the Fed respond?

Is credit card debt effected by bank reserve requirements?

John M. Berry: Tax cuts, which would give taxpayers more disposable income to spend than they otherwise would have had, would tend to stimulate an economy already threatening to overheat. Paying down the national debt by running a budget surplus has the opposite effect. Greenspan said last week that the Fed does not respond to changes in fiscal policy but to any changes in the economy that result from shifts in fiscal policy. But a very large tax cut, such as the one proposed by congressional Republicans last year, might have stimulated the economy enough to trigger additional rate increases by the Fed.
As for the other question, no, I don't think there is any connection.

Lynchburg, VA: If interest rates do go up as expected, what do you think the effect will be on mortgage rates? And, what advice would you give someone buying in the near future - i.e. 30 year fixed vs. adjustable rate mortgages?

John M. Berry: The precise impact is hard to predict. Because most of the money that funds home mortgages is raised in the bond market through the issuance of mortgage-backed securities, yields in that market heavily influence mortgage rates. In particular, changes in yields on 10-year U.S. Treasury notes have the most impact. Those yields have been rising for some time, both because of the strong overall demand for credit in the booming U.S. economy and because of expectations that the Fed will raise its target for short-term rates. So investors probably have fully discounted this week's expected action by the Fed and a quarter-point increase might have little if any effect on mortgage rates. However, what the Fed says in its announcement could give the market added information about Fed thinking and that could move yields up or down.
As for fixed vs adjustable, think about how long you expect the mortgage to be in force. That is, do you plan to sell your house within a short time or keep it for many years? The key is the average interest rate you will pay over the life of the mortgage. ARM's usually start with a rate lower than the index to which they are tied plus the spread between the index and what you pay. So in the second year, the rate may well rise. Check what the ARM rate would be today if you had taken it out two or three years ago. Of course, check out what it would cost you to refinance an ARM later on should you want to switch to a fixed rate.

Philadelphia, PA: I've been following your work for a while. Given the bearish economic numbers released Friday, what % probability would you give to the Fed raising the Fed funds rate 50 bps this week?

John M. Berry: Like almost all analysts that I have spoken with recently, I think the odds favor a 25 basis point increase. A 50 basis point increase likely would be taken one of two ways in the market: one, the Fed thought that was going to be enough and that it was done for awhile, or two, that inflation was about to get out of hand and large additional increases likely are on tap. I doubt the Fed will want to leave either of those impressions, particularly with core inflation still so well behaved. While they want growth to slow, they don't want to suggest any sense of panic. Greenspan has a history of gradual changes in rates and I think that is the best guide to what is likely this week.

Bethesda, MD: Right now we are entering the country's greatest period of expansion. Do you have thoughts on how much longer that can last and will the Fed's preemptive moves curb that level of growth?

John M. Berry: The Fed has a multiple legal mandate to foster stable prices, maximum employment and moderate interest rates. The Fed has taken the position that the best way it can contribute to maximizing employment is to keep inflation low so that the economy can growth on a sustainable path. Right now, Greenspan and other officials have made it clear they believe that the economy can growth noticeably faster than it could only a few years ago because of the acceleration of productivity growth. But they don't think sustainable growth is anywhere near 5.7 or 5.8 percent, the GDP growth rates in the third and fourth quarters of last year. So they want to slow things down and avoid more inflation precisely to keep the expansion going indefinitely.

Washington, D.C.: How do you think the stock markets would react to a half point increase? I presume you think they've already factored in a quarter point increase

John M. Berry: I know a lot more about the Fed than I do about the stock market! I think your presumption about investors' expectations for this week is correct. The reaction to a half point increase probably would depend heavily on what the Fed said in the announcement explaining the action.

Hopewell Junction, NY:
Does the Fed have advance notice of Economic Data released shortly before the FOMC meeting? Specifically, Unemployment is released on Friday, 4 February; will the Fed have that data available to them during the FOMC meeting on 1-2 February?

John M. Berry: At the time the FOMC takes up the issue of interest rates on Wednesday morning, not even the Bureau of Labor Statistics will know all of the key figures. When BLS finalizes the Employment Situation report on Thursday afternoon, it sends a summary to the chairman of the Council of Economic Advisers by secure fax. The CEA chairman has been designated by the president to get the data. The CEA, with the president's authority, then shares the figures with the White House, the secretary of Treasury and the Fed chairman. So, no, the Fed will not have the data when they meet.

© Copyright 2000 The Washington Post Company

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