Federal Reserve officials expressed confidence yesterday that Hurricane Katrina has caused no more than a temporary setback to the U.S. economy, allowing them to raise their key short-term interest rate another notch to make sure inflation stays under control.
As the federal government and insurance companies begin to put tens of billions of dollars into Gulf Coast reconstruction, Fed policymakers expressed more worry about rising inflation pressures than slower economic growth and indicated that they will probably keep raising interest rates in the months ahead.
Private economists are forecasting that the economy will gain more from the reconstruction spending than it has lost because of the storm.
In an unusually long and sympathetic statement released after their meeting, Fed officials noted "the widespread devastation in the Gulf region . . . and the boost to energy prices" resulting from the storm, which displaced thousands of area residents, wiped out hundreds of thousands of jobs, disrupted shipping systems throughout the Mississippi Valley and shut down much of the nation's oil and gasoline production.
In the first week after Katrina hit, economists worried that consumers and businesses might react to soaring energy prices by sharply pulling back on spending plans, triggering a sudden slump. Some Fed officials were open then to the possibility of leaving interest rates unchanged for a while because of the uncertainty of the economic outlook.
But since then, energy production has recovered somewhat, while oil and gasoline prices have come down from their post-Katrina peaks.
By yesterday, Fed officials had concluded that national consumer spending, employment and overall economic growth "will be set back in the near term" because of the storm.
Looking out over the months ahead, they added, "while these unfortunate developments have increased uncertainty about near-term economic performance, it is the [Fed's] view that they do not pose a more persistent threat."
Rather, Fed officials said, low interest rates continue to stimulate economic growth, while "higher energy and other costs have the potential to add to inflation pressures."
Already, prices have climbed for building materials and transportation services. Economists are watching closely to see how successful other businesses are at raising consumer prices to cover their higher energy costs. That may become easier at a time when consumers say they are expecting higher inflation than they did before Katrina.
The central bank's top policymaking group, the Federal Open Market Committee, was more divided yesterday than it has been in more than two years. Nine of the 10 voting members, including Chairman Alan Greenspan, agreed to raise their benchmark federal funds rate to 3.75 percent from 3.5 percent.
Fed board member Mark W. Olson voted against the move, saying he preferred to leave the rate unchanged -- the first dissent on the committee since June 2003.
Some other committee members came to the meeting open to Olson's position; only seven of the 12 regional Fed banks had requested a similar quarter-percentage-point increase in the largely symbolic discount rate to 4.75 percent -- a sign that five Fed banks might have been content with no increase in the funds rate either. The discount rate is charged to commercial banks when they borrow directly from the Fed.
The federal funds rate influences many other borrowing costs throughout the economy. Major banks followed the Fed's action by lifting their prime rate on business loans by a similar quarter percentage point, to 6.75 percent from 6.5 percent. Many consumer rates, such as on credit cards and home equity loans, may rise as well. Banks and other financial institutions may increase the rates they pay on savers' certificates of deposit and money market funds.
However, long-term rates, such as those charged on 30-year mortgages, are determined by global markets. Those rates have remained low over the past 15 months, even as the Fed hiked short-term rates. For example, the fixed rate on a 30-year mortgage averaged 5.74 percent nationally last week, about where it was a year ago at 5.75 percent, according to mortgage finance company Freddie Mac.
The Fed committee made it clear that it plans to keep raising the federal funds rate in the months to come, repeating that it believes it can do so gradually, "at a pace that is likely to be measured."
Stock prices fell on concern that higher interest rates will dampen economic growth and profits.
Fed officials stressed their belief that the economy was in solid shape before the storm hit.
Consumers and businesses increased spending rapidly during the summer, while unemployment fell to a low 4.9 percent in August, and price inflation outside of the energy sector was tame.
The economy "appeared poised to continue growing at a good pace before the tragic toll of Hurricane Katrina," the Fed statement said.
Fed officials did not mention it, but they are also well aware that the post-hurricane reconstruction will provide a strong stimulus to national economic growth. Insurance companies are preparing to pay about $50 billion in claims. Congress has appropriated more than $60 billion in assistance, and President Bush has proposed a federal response that could cost up to $200 billion by some estimates.
The result will be a net plus for the economy, according to estimates by Macroeconomic Advisers LLC, a St. Louis forecasting firm. The economy will grow by a healthy 3.4 percent in 2005, or roughly 0.2 percentage points slower than it would have without Katrina; the economy will then expand by a robust 3.8 percent next year, or 0.5 percent more than without the post-hurricane spending burst, the firm said yesterday.
The Fed's action was its 11th consecutive quarter-percentage-point increase in the federal funds rate, the overnight rate charged on loans between banks, since June 2004, when it was at a four-decade low of 1 percent.
Many investors and analysts have come to expect a "measured" pace to mean a quarter-percentage-point increase at every scheduled Fed meeting. But Fed officials have stressed that they could pause or increase the rate by as much as a half percentage point at a time, depending on the behavior of the economy.
Thus Fed policymakers might leave the fed funds rate unchanged at their next meeting Nov. 1 if the economy slows more than they expect. Or they could raise the rate by half a point if inflation takes off.
Several analysts predicted that Fed meetings will include more debate and possibly more dissents as the rate goes higher and as Greenspan prepares to step down early next year.
"Greenspan certainly has the intention of raising rates" higher, said Anthony Chan, senior economist for J.P. Morgan Asset Management. But, he said, "moving forward, there will be more challenges to that."