Interest rate increase aims to slow growth without stopping it

Growth continues to accelerate. And that worries the Federal Reserve Board chairman and his fellow policy-makers, who on Tuesday approved their fifth quarter-point boost in interest rates since June.

"The Fed wants growth to moderate," said Bruce Steinberg, the chief economist at Merrill Lynch & Co. in New York, "but they do not want the economy to come to a halt."

Analysts believe the Fed has a speed limit in mind: annual growth of 3.5 percent to 3.75 percent.

At that rate, they say, the economy can grow without causing inflation.

"Their main concern is inflation," said Phil White, the Plano branch manager for Prudential Securities.

Mr. White said Wall Street expects two more quarter-point rate increases in the federal funds rate by the Fed's August meeting.

That would leave the interest fee that banks charge one anoth!
!
er on overnight loans at 6.5 percent.

The central bank raised the federal funds rate to 6 percent in a closed-door meeting Tuesday.

In an announcement, the Federal Open Market Committee indicated that growth was still too robust.

"The committee remains concerned that increases in demand will continue to exceed the growth in potential supply, which could foster inflationary imbalances that would undermine the economy's record economic expansion," the Fed said.

Some private economists contend that the Fed's actions are not needed because there are few signs of a surge in prices.

But in any event, the economy shows few signs of cooling.

It expanded by a whopping 6.9 percent in the final three months of 1999, and analysts expect that growth may exceed 5 percent during the first quarter of this year.

Treasury Secretary Lawrence Summers said growth would remain strong but predicted that the pace would moderate.

And he noted that business investment had improved pro!
!
ductivity, which helps control inflation.

"I am sure there will be fluctuations," Mr. Summers said in Dallas during a meeting with editors and reporters at The Dallas Morning News.

"[But] I wouldn't expect the nearly 7 percent growth rate of the last quarter to endure," he said.

So far, Mr. Greenspan has tried to bring growth under control with a series of incremental rate increases. Commercial banks are expected to fall in line behind the Fed's latest increase and ratchet up their own rates, as Bank of America did Tuesday with a quarter-point boost in its prime lending rate to 9 percent.

As interest rates rise, the cost of borrowing money for investment or to acquire goods and services becomes more expensive.

So far, consumers have not lost their taste for spending. And consumer confidence levels remain high, as measured by the Conference Board business research group. "We really have not seen a meaningful economic slowdown," said Sung Won Sohn, chief econo!
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mist at Wells Fargo Bank of Minneapolis.

Mr. Sohn refers to the Fed's strategy as "slow-motion monetary policy" and advocates swifter steps so the economy and financial markets can absorb higher interest rates more quickly.

So when will the Fed's actions begin to show up in slower growth?

Economists say it takes about 12 to 18 months before an interest rate change has a measurable effect on the economy.

With that in mind, analysts say they think that the pace of growth will moderate after June and may even drop below the Fed's targets.

If growth slows as expected, it will do so just as this year's political campaign heats up.

"But if inflation is moving up as we move into the [campaign] home stretch, then the Fed will do what it has to do," said Paul Kasriel, an economist at Northern Trust Co. in Chicago.

The Fed's strategy does have risks.

If the central bank raises interest rates too high, analysts say, it could cause a drastic stock market correction.

"!
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This risk is you deflate the stock market, and you [have] a very rapid slowdown in domestic demand," Mr. Kasriel said.

Most economists say the bull market of the late 1990s has substantially boosted family wealth and encouraged consumers to spend.

A sharp sell-off and a depressed market could trigger the opposite reaction.

But analysts say that while the risk is real, it is not high.

"They could reverse this by lowering interest rates," said Mr. Steinberg, the Merrill Lynch economist. "The reality is that our economy remains strong and in excellent shape."

Staff writer Dianne Solis in Dallas contributed to this report.