Greenspan's Rates of Wrath

The Fed jacks up borrowing costs, but the move is too much for Main Street and not enough for Wall Street

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Less partisan Fed watchers argued that Greenspan should declare victory in the war against inflation and stop driving up rates. "Further increases on top of the one this week could absolutely push the economy into a recession," warned Lacy Hunt, chief U.S. economist of HSBC Holdings, a bank holding company. Ford chairman Alex Trotman had similar misgivings. "Another hit like this one and I start to get concerned," said Trotman, who learned of the latest Fed move while unveiling the 1995 Continental (estimated sticker price: more than $35,000) at a Washington gala. "I'd start to feel that we might not only slow the momentum in auto sales but kill it."

Defenders of the rate hikes make the following case: with unemployment at just 5.8% and factories humming along at nearly 85% of their capacity, the U.S. economy is in a dangerous zone. "These are the classic signs of an overheating economy," says Lyle Gramley, a former Fed governor who is chief economist for the Mortgage Bankers Association. "It's very clear what's happening, and it's something that people who don't look beneath the surface don't acknowledge."

In this view, the Fed is likely to keep tightening credit until the economy slows from a feisty 3.4% rate of growth in the third quarter to a more sustainable 2.5%. If the Fed can achieve that goal, it would accomplish a rare "soft landing," the jargon for slowing just enough to restrain inflation without sending the economy into a slump.

But critics argue that there is no need for such maneuvering, which risks bringing on a recession, because inflation is already under control. Such economists gained support last week when the government reported that the Consumer Price Index, a key gauge of inflation, had risen in October by a minuscule 0.1%.

In addition, the Fed's critics insist that traditional warning signs of inflation like high rates of factory utilization are no longer reliable. That's because the U.S. economy has become so productive, they argue, that companies can build and sell more of everything, from cars to computers, without having to push up prices. At the same time, U.S. firms have ) constructed so many factories abroad that measurements of how fully they are using their plants at home no longer indicate their true capacity.

All this has led some critics to assert that the Fed has been paying less attention to what is happening in the economy than anticipating the psychological reactions of the bond market. They see a parallel in the way the Clinton Administration decided last year that any push to stimulate the economy would cause bond investors to detect the threat of inflation and lead to higher interest rates.

For a moment last week, the bond market's psyche was easy to read. So eager were traders for higher rates that William Reynolds, director of fixed-income investments for the T. Rowe Price group of mutual funds, dreamed the previous night that the Fed had failed to act. In the nightmare, Reynolds said, "we were running around the office yelling, 'They've got to do something; they've got to do something!' " When news of the rate hike flashed across his screen, Paul Boltz, the chief economist for the funds, exclaimed, "Oh, they took my advice! Oh, this is good!"

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