article titled ‘Fed Unlikely to Alter Course’ by John M. Berry of the Washington
Post takes an interesting look at actions that Alan Greenspan his colleges of
the Federal Reserve have been taking over the last 9 months to slow the economic
growth of United States. The astonishing growth rate of 7.
3% is fueled by an
economy that is in the midst of a “high tech revolution”. The article
also explores the contrasting view of other economists that say that the Fed has
increased interest rates too much in its attempts to slow the economy. The means
by which Alan Greenspan and the Federal Reserve have chose to slow the economy
is through a monetary policy, or more specifically, an increase in the national
interest rate. The article states that the Fed officials have come to a
“broad agreement that they will keep raising the rates until growth slows
to a more sustainable pace to make sure inflation stays under control.
Because of the booming economy and the investment in the stock market the
exchange of money has increased for goods and services, which in turn increases
the price level or the quantity of money demanded. By increasing the interest
rates the Fed commits itself to adjusting the supply of money in the United
States to meet that rate at a point of equilibrium. If the interest rate is
increased, less goods and services are demanded, and therefore will slow down
the economy and reduce the rate of inflation. The article points out that as
“stock prices have risen over the last couple of years, so have American
household wealth and consumer spending.
” This is precisely the cycle that
Fed officials want to interrupt to slow growth before it fuels more inflation.
At the time this article was written the stock market prices had fallen sharply
especially in the technology sector. But the Fed continued on the path to raise
interest rates further noting that the index that they closely follow and
contains a broader rage of public traded US stocks, the Wilshire 5000, is up for
the year. Even though they began raising rates gradually 9 months ago, it takes
almost a year for the economy to feel the full effects.
In this case the results
of the interest rates increased could be felt as last as the second half of
2000. Yet the economy has not slowed down, and the demand for goods and services
continues to increase as wealth does. One of the ideas that has been presented
to Greenspan by the fed officials was to take bigger steps in raising the
interest rates. They feel that this will decrease the money demand in a quicker
In turn these actions will lead to lower consumer spending, and thus
decrease the inflation rate. However, because of the erratic patterns in today’s
high tech economy Greenspan is expected to stick to his pattern of more gradual
increases to the interest rate. Eventually when monthly loan payments increase
enough, consumers will back on purchases and investments. The article points out
an example where the rate for a new 30 year fixed-rate home mortgage is up to
5% from 7.75% nine months ago in June. In the situation of a $150,000 home
loan, this new interest rate will add almost $100 to each monthly payment. Over
time the full effect of the interest rates will be felt.
One economist, James
Glassman of Chase Securities takes a different look at the new interest rate. He
points out that the rates that the Fed has set are fairly high in comparison to
the rate of inflation as it is currently in the United States. The formula that
Glassman follows examines the inflation rate when food and energy items are
excluded because they are so volatile. With these items removed the rate of
inflation in the US is less than 2%.
As with other measurements, this rate can
be subtracted from the interest rates to find a ‘real’ interest rate which
consumers a paying. So in terms of 30-year home mortgage rate set at 8.5%, only
6.5% of it is what the consumers are actually paying and the rest is accounted
for by inflation.
Glassman goes further to point out that “with inflation
so low, wages aren’t going up all that fast.” To be said more specifically,
the interest rates are increasing faster than consumers’ wage increases. This
will eventually be felt in the tightening of the American economy. However with
stock market fueling the incredible momentum