Federal Reserve policymakers, concluding that economic growth must be slowed to prevent the lowest unemployment rate in a generation from falling further and generating more inflation, raised short-term interest rates yesterday by a quarter of a percentage point.
The increase to 5.5 percent in the Fed's target for the federal funds rate--the interest rate financial institutions charge one another on overnight loans--will make borrowing more costly to consumers and businesses. As that happens, Fed officials expect economic growth and the demand for workers to ease as households and businesses trim their spending plans.
At the same time it raised rates, the Federal Open Market Committee, the central bank's top policymaking group, adopted a "symmetric" directive, indicating its members made no presumption about whether their next move on rates would be to raise or to lower them. At the previous FOMC meeting early last month, the committee said it was leaning toward raising rates, as it has now done.
The key to yesterday's action was a significant decline last month in the nation's pool of available workers who don't hold jobs. The official unemployment rate dipped in October from 4.2 percent to 4.1 percent, the lowest level since January 1970.
The size of a separate group of workers, who weren't officially unemployed because they weren't actively looking for work but said they were available and would like a job, also declined noticeably.
The continuing shrinkage in this pool of workers is a sign that economic growth is still running at an unsustainably high pace, Fed Chairman Alan Greenspan believes.
The possibility of a rate increase had been widely discussed in advance of the meeting, and many analysts had regarded the outcome as a tossup. Immediately after the Fed's announcement, stock prices gyrated and then rallied, with the Dow Jones industrial average rising 171.58 points, or 1.59 percent, to close at 10,932.33. Yields on U.S. Treasury securities rose modestly because of a slight decline in bond prices, which move inversely to the yield.
This was the Fed's third quarter-point increase in its federal funds rate target since late June. Since many banks keep their prime lending rate 3 percentage points above the fed funds rate, yesterday's move means that the interest rates charged on many consumer loans, such as unpaid credit-card balances and home equity loans, will go up.
The impact on 30-year fixed-rate home mortgage loans is uncertain because they are loosely linked to yields on 10-year U.S. Treasury notes, which may or may not change. However, the rates charged on variable-rate mortgages may rise.
Several Fed officials have said that regardless of the outcome of today's meeting, it is unlikely that rates would be changed at the next FOMC meeting on Dec. 21. That is because of the possibility of financial market disruptions related to the year 2000 computer date change.
Going into the FOMC meeting, the members were divided over whether rates needed to be increased. Some who wanted to keep rates unchanged pointed to signs that growth in some parts of the economy, including housing and auto sales, was already slowing. In addition, those officials argued, there is little if any evidence that tight labor markets are causing wages to go up in an inflationary fashion or that inflation is picking up.
The announcement of the rate increase acknowledged those points but said that wasn't enough.
"Although cost pressures appear generally contained, risks to sustainable growth persist," the statement said. "Despite tentative evidence of a slowing in certain interest-sensitive sectors of the economy and of accelerating productivity, the expansion of activity continues in excess of the economy's growth potential.
"As a consequence, the pool of available workers willing to take jobs has been drawn down further in recent months, a trend that must eventually be contained if inflationary imbalances are to remain in check and economic expansion continue," it said.
Separately, the Federal Reserve Board, whose members are all also members of the FOMC, raised the Fed's discount rate, the interest rate financial institutions pay when they borrow money from a regional Federal Reserve bank, to 5 percent from 4.75 percent. This increase had little significance, analysts said, because the Fed tends to keep that rate a quarter- or a half-percentage point below the level of the fed funds rate.
Analysts also said the "symmetric" directive did not preclude further rate increases in the first part of next year.
"No new ground has been broken in this directive, and we believe it leaves the door open for more tightening in 2000 if such is warranted by the data in the months ahead," said Dana Saporta of Stone & McCarthy, a financial markets research firm.
"It is highly unlikely, in our view, that the FOMC will choose to tighten as soon as its next meeting on Dec. 21. Even the most ardent Y2K optimists would not think of tightening money market conditions that close to the century date change. But the policy vote at the Feb. 1-2 meeting is more of an open question," Saporta said.
CAPTION: RAISING THE RATE (This chart was not available)
CAPTION: Broker Paul Candeletti, right, waits on the trading floor of the New York Stock Exchange yesterday for the Federal Reserve's decision on interest rates. Fed policymakers raised a key short-term rate by a quarter-percentage point.