We've been here before.
It's March 1997.
fires a warning shot to the market in a
speech before the
Joint Economic Committee
, expressing the Fed's aim to be "preemptive" with regard to monetary policy. Markets brace for a series of rate hikes, as when the Fed delivered seven hikes between February 1994 and February 1995.
The Fed hikes rates five days later -- and not since.
Tomorrow, Greenspan will testify on monetary policy before the same committee, and it's expected to be a prelude to a rate hike at the June 29-30 Fed meeting. So what happens next? On the surface, the economic conditions in 1999 are not dissimilar from those two years ago -- labor markets are tight, productivity and growth are strong and prices are low. But there are differences now that lead some economists to believe the economy is looking at more than one rate hike.
"Inflation fizzled completely after the
March 1997 move," says Russ Sheldon, chief economist at
. Now the "Fed is faced with extremely strong demand numbers and can make the case that it could cause an inflation rise in the future."
A Good Idea at the Time
In 1997, Greenspan said it was important to "act promptly -- ideally preemptively -- to keep inflation low over the intermediate term and to promote price stability over time" to maintain the current economic strength. At the time, he also was very concerned with the tightness of the labor market. The Fed chairman was of the opinion that 1997's "resource utilization rates -- particularly of labor -- have been in the neighborhood of those that historically have been associated with building inflation pressures."
Greenspan was referring to the 82.6% rate of capacity utilization and the drop in the unemployment rate to 5.1%, compared with 5.5% in March 1996. Meanwhile, the
Employment Cost Index
for the first quarter of 1997 rose at a 2.9% yearly rate, and
average hourly wages
were rising at a 4.1% year-over-year rate, compared with 2.9% a year earlier.
But economists say the Fed jumped the gun in 1997. Key inflationary price measures were slowing -- the core
Consumer Price Index
, which excludes food and energy prices, was rising on a year-over-year rate of 2.5%, compared with 2.8% in March 1996. Greenspan acknowledged this in his speech but was more concerned with the potential for higher costs of producing goods, in terms of both labor and business investment.
It didn't happen -- companies increased productivity without a marked increase in costs, due to technology improvements and favorable borrowing conditions, economists say. The Fed reversed course, and though it threatened a hike by adopting a bias toward tightening in 1998, it never got the chance due to the global crisis that resulted in three quarter-point rate cuts from 5.5% to 4.75%.
"We've had great benefits on the supply side in terms of the doubling of productivity growth, in terms of temporary, contract-type laborers," says David Jones, chief economist at
Aubrey G. Lanston
Average hourly wages now are rising at a 3.6% year-over-year rate, even as the unemployment rate has declined to 4.2%. The ECI is currently rising at a 3% year-over-year rate, and the core CPI is rising just 2% annually. Capacity utilization is currently 80.5%.
"It's clear that the inflation forecasts were much too high for 1997," Sheldon says.
Supply vs. Demand
What also constrained the Fed in 1997 was that demand, though strong, wasn't perceived as the steamroller it is today. Part of the reason for this was tighter monetary policy -- the fed funds rate was 5.25% prior to the rate hike, compared with 4.75% now. A tighter policy restricts the growth of money supply and boosts long-term lending rates, including mortgages and auto loans.
"In the last year the Fed has eased, money supply growth is rapid and nominal GDP has accelerated," says Mickey Levy, chief economist at
Banc of America Securities
. "This is a demand-driven boom, which is a different nature of economic growth than in 1997." Nominal GDP refers to the increase in growth that results from higher prices.
Though the stock market's so-called wealth effect was believed to be buoying spending, other conditions were not as favorable for consumers in 1997. The 30-year Treasury bond's yield was near 7%, compared with the sub-6% levels that borrowers enjoyed for the last year and a half. Low mortgage rates during 1998 and 1999 caused a spike in mortgage refinancing, putting extra money into many consumers' pockets. Most recently
were rising at an 11% year-over-year rate of increase; in March 1997 sales were rising at a 5.5% rate.
"They're allowing demand to be very strong," says Sheldon. "I think they've lost patience with waiting for demand to slow and they see the need for some restraint."
They'll Know it When They See It
All three economists interviewed agree that the current economic conditions are potentially more inflationary than in 1997 -- labor markets are tighter, Fed policy is still looser and consumer demand is stronger. Levy and Jones believe the Fed is likely to raise rates two or three times.
Will one quarter-point rate hike, as the majority believe will be undertaken, slow demand to a rate that the Fed is comfortable with? Sheldon says the recent rise in Treasury yields will slow spending on big-ticket retail items, and "we could get more modest growth rates pretty quickly."
If not, and demand continues to grow, the Fed is left in a pickle: Fear and prudence are enough to let them hike rates once; only inflation justifies a series of rate hikes.