Like Goldilocks, Federal Reserve officials like their porridge--and the U.S. economy--not too hot and not too cold. On Tuesday they'll meet, take a taste and decide whether they need to adjust the monetary policy burner to keep the temperature just right.
Most financial analysts are betting Chairman Alan Greenspan and his colleagues will continue a process they started at the end of June and raise short-term interest rates by another quarter-percentage point. It's not that the porridge is too hot at the moment, Greenspan explained later, but it might get scorched before long if the burner isn't turned down now.
The Fed's concern is that with the jobless rate at 4.3 percent, close to a three-decade low, it might not take much overheating to spur higher inflation. But with no concrete evidence that is going to happen, the June policymaking session was a contentious one. Some of the officials think next week's meeting will be a replay.
Even though a rate increase looks likely, some of the analysts said that recent economic news, particularly continued reports of low inflation, suggest that the Fed might remain on hold and wait for more information about the economy's course.
If rates are raised on Tuesday, many Fed watchers think the central bankers would be unlikely to follow with further increases at their October or December meetings. Nevertheless, a smaller number of analysts believe economic growth and potentially inflationary wage gains may lead to additional rate increases before the year is out.
Investors and traders in both the stock and bond markets already have factored a rate increase next week into their thinking, and some analysts said if the Fed doesn't move it probably would send stock prices surging. That's the last thing many Fed officials would like to see, since they have long been worried that the big stock market profits are fueling a consumer spending boom that has complicated their efforts to keep the economy at an ideal temperature.
"Everybody is assuming the Fed is going to tighten," said Mickey Levy, chief economist for Bank of America in New York. "They are likely to, and the market thinks this is a slam dunk, but I think it is closer than that."
Bill Dudley, chief economist at Goldman Sachs & Co. in New York, agreed.
"Tightening still looks like the most likely outcome," said Dudley, chief economist at Goldman Sachs Group Inc. in New York, who is among those anticipating action to raise the Fed's target for overnight interest rates to 5.25 percent from 5 percent. "But with inflation well-behaved, Fed officials do have the option to wait without running much risk to their credibility as inflation fighters," he said.
The difficulty is that neither Greenspan nor any of the other 16 officials with a voice in next week's decision can be certain what course the economy will take in coming months. As always, they have to set a target for short-term rates on the basis of highly uncertain economic forecasts.
For instance, Greenspan and many of the other policymakers have said they believe the economy can grow at a 3 percent pace, perhaps even more, without putting additional pressure on the nation's tight labor markets. In the April-June period, growth dipped to an estimated 2.3 percent annual rate, down significantly from gains over most of the past three years--and that figure may well be revised downward because of the record trade deficit for June, reported yesterday. However, some of the slower growth may have been due to temporary factors, such as businesses increasing the inventories of unsold goods more slowly than expected.
Economist Joel Prakken of Macroeconomic Advisers, a St. Louis forecasting firm, expects the slower pace for growth to continue, following more than three years in which the U.S. economy, as measured by the inflation-adjusted gross domestic product, grew close to 4 percent annually. His firm's latest forecast showed growth at a 2.8 percent rate in both the current quarter and the final three months of the year, and since it was made a few weeks ago, "the data has convinced us that we should be revising down our number," he said.
However, the slower growth is coming too late to prevent some acceleration in consumer price inflation, which should be up to a 2.5 percent to 3 percent rate by the end of the year, Prakken predicted.
Prior to the end-of-June rate increase, Greenspan had begun talking in public about the need for the Fed on occasion to be "preemptive" in its monetary policy decisions--for instance, raising rates in advance of a possible acceleration of inflation even when the current figures show no such increase. When that Fed action was announced, the wording of the statement was intended to keep the financial markets from jumping to the conclusion that a whole series of increases was planned. And the chairman emphasized that fact in later congressional testimony.
Some Fed officials are convinced that growth has begun to slow, as they have long expected it to. A rise in long-term interest rates set by the market has raised borrowing costs for both individuals and businesses and undoubtedly dampened spending by both to some extent. Home building, one of the hottest parts of the economy, is cooling off at least somewhat, according to surveys of builders.