- The Washington Times - Wednesday, August 23, 2000

The Federal Reserve, noting that economic growth has slowed recently, yesterday left interest rates unchanged. But the central bank said it would stay on alert because of a lingering inflation threat.

In an upbeat statement after a daylong meeting of its rate-setting committee, the central bank said "rapid advances in productivity" have enabled the economy to grow faster without igniting inflation. But it said that it remains wary because a shortage of workers is straining resources throughout the nation.

Economists said the statement shows the Fed is satisfied that its six rate increases totaling 1.75 percentage points since June 1999 are starting to moderate growth. Most said the Fed will not raise rates again before the elections and perhaps not again until next year.

"They think they've got it," said Joel Naroff of Naroff Economic Advisers in Holland, Pa., noting the tone of certainty in the Fed's statement. "The Fed seems to think that we can grow quickly without inciting inflation" and "will stand pat unless it has conclusive evidence that inflation is accelerating."

Over the past 14 months, the Fed has raised rates six times, pushing its target for the federal funds rate, the interest that banks charge on loans to each other, up to 6.5 percent, including a half-point increase on May 16.

Those increases have raised the borrowing costs for millions of Americans with banks' prime lending rate, a benchmark rate for many consumer and business loans, now at a nine-year high of 9.5 percent. The prime rate stood at 7.75 percent before the Fed began its drive to push rates higher in June 1999.

Financial markets mostly anticipated yesterday's good news, but got an extra boost out of the positive tone of the Fed statement. The Dow Jones Industrial Average ended up 59.34 at 11,139.14, led by the rebounding fortunes of financial stocks like Wells Fargo and J.P. Morgan that thrive on lower interest rates.

Mr. Naroff said he doesn't think the Fed will even consider raising rates again until December, when it will have a clearer picture of how pronounced the slowdown in growth and inflation has been. Most economists say growth is slowing to around 4 percent from rates as high as 7 percent late last year.

"The Fed is still worried that if growth stays above 4 percent, it could create higher inflation," Mr. Naroff said.

David Orr, chief economist with First Union Bank in North Carolina, said "the Fed would tighten in a heartbeat" if inflation spikes unexpectedly in coming months. But he, too, noted a new sense of confidence coming out of the Fed.

The conclusion of the 12-member Fed committee, in particular, that growth can be higher because of the unusually fast growth of more than 5 percent in worker productivity in the last quarter is its first such "definitive" statement on that much-debated topic, he said.

Martin A. Regalia, chief economist of the U.S. Chamber of Commerce, said the jump in productivity means that the discipline and hard work of America's labor force is helping the Fed achieve its goal by keeping inflation in check.

"Housing, employment and consumer spending are all easing in response to Fed rate hikes," he said. "We have not yet seen all the effects from the past six rate increases, so it is imperative that the Fed continues its wait-and-see policy over the next several months."

Some economists said the economic slowdown is modest at best and the Fed is resting too soon. The economy could return to runaway growth rates later this year, setting off a more serious bout of inflation, they said.

"Not only will there not be a soft landing, there won't be a landing at all," said Richard Yamarone of Argus Research Corp. in New York. "The American economic expansion continues to soar into record territory unfettered by the strongest of agitating winds."

Last year's light dose of rate increases will not be enough to clip the economy's wings, he said.

For years now, "the economy has shown an utter resilience to negative economic, global, political and financial influences," including the Mexican peso crisis, the Asian financial crisis, Russia's default, Japan's decade-long recession, a stock market crash and a presidential impeachment.

"With such resilience, why expect a slowdown now?" he said.

With the economy still running strong, manufacturers and retailers are more likely to pass on sharply rising energy costs, and add in a few pennies to plump up their profits in a troubling development for the central bank, Mr. Yamarone said.

That is why the Fed remains on "high alert," he said, calling the soaring prices of crude oil, natural gas and electricity a "compromising influence in the economy's tea leaves."

• This article is based in part on wire service reports.

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