Tighter Fed Policy Raises Stakes for Continued Economic Growth

Article excerpt

WASHINGTON The latest increase in short-term interest rates fulfilled bond market wishes for a tighter policy from the Federal Reserve, but it also increased the chance that the economy will slow to a crawl in 1995.

Increasingly, Fed officials find themselves caught between the pressures of financial markets and an uneasy public that will be paying more for adjustable-rate mortgages, home equity loans, and other popular types of credit.

Interest rates are now higher than they have been in three years, wiping out any bond market gain that resulted from President Clinton's deficit reduction program. The rate on 30-year, fixed-rate mortgages has reached 9.20%, up from only 7.08% a year earlier.

Short-term rates, which are most directly affected by the Fed when it tightens credit, are also up sharply. Commercial banks have pushed up the prime lending rate to 8.5%, from 6% at the beginning of the year, and one-year. adjustable-rate mortgages have climbed to 6.10%, from 4.20%.

Analysts at DRI/McGraw-Hill Inc., the forecasting firm in Lexington, Mass., believe the economy's pace will slacken considerably by next summer and won't be far from grinding to a halt. They predict the Fed will raise short-term rates one more notch, to 6%, while economic growth slows to a little better than 1% beginning next spring.

"I believe that we are getting close to a traditional recession," said Roger Brinher, executive director of research at DRI.

Mr. Brinner was surprised by the renewed burst of spending last summer by households with incomes over $40,000 for cars, furniture, and other high-priced durable goods. This spending spree gave the economy an unexpected lift and forced the Fed to take a more aggressive stance in tightening credit, he said. …