Why Greenspan Is Getting An Itchy Trigger Finger

These should be blissful times for Alan Greenspan. The economy is growing robustly, while inflation is holding at a comfortable 3%. So why are beads of sweat breaking out on the Federal Reserve chairman's brow? Because after leaving interest rates unchanged for 18 months--the longest period of stability in the central bank's history--the time to give rates an upward nudge is approaching quickly.

The move could come as early as the Feb. 3-4 meeting of the policy-setting Federal Open Market Committee. Fed sources say there's growing sentiment within the 12-member FOMC not to wait any longer to increase the "federal funds" rate that member banks charge each other for overnight loans. The rate, which has been at 3% since September, 1992, could rise by a quarter-point. "Several [members] believe it's time for some modest snugging," says one source.

Surprisingly, even the Clinton Administration isn't worried that a small tightening move will hurt the economy, though it would prefer that the Fed acted later rather than sooner. The Administration's own 1994 forecast, due out in early February, will assume that short-term rates rise by 40 basis points this year.

"CLOSE CALL." The argument for higher rates now is that the Fed has to send financial markets a signal that it remains vigilant against inflation as growth accelerates and prices firm. Waiting too long might require more drastic action that could hurt the economy. "If you wait until you see the whites of the eyes of inflation, it's probably too late," says Fed Governor Lawrence B. Lindsey. He adds that conflicting data on inflation make it "a close call" whether to push for a rate hike now.

Inflation fears are fed by the fact that the consumer price index, excluding its volatile food and energy components, rose at a 3.4% rate in the last three months of 1993, up from a 1.9% pace in the third quarter. Double-digit increases in the prices of gold and other commodities, such as steel scrap and lumber, and rising capacity utilization also provide warning signs.

The not-to-worry camp points to falling oil prices, slack global demand, and productivity gains that are holding labor costs down. "The back of inflation has been broken," declares Lehman Brothers Inc. chief economist Allen Sinai, who predicts the CPI will rise just 2% to 2.5% this year. But even with such a rosy forecast, Sinai thinks a quarter-point rise now would be a sound move to preempt inflation.

DOUBLE WIN? Of course, the Fed looks at more than economic considerations. Political concerns may prompt the FOMC to defer action until after Feb. 22, when Greenspan is scheduled to lay out his policy goals for the year before a House Banking subcommittee. Banking Chairman Henry B. Gonzalez (D-Tex.) is already on Greenspan's case over what he regards as the Fed's excessive secrecy in policy deliberations. The Texas populist will not be as understanding as the Administration about the need for a rate hike. And Greenspan, who is locked in an increasingly nasty fight with the Administration over a plan to consolidate all bank regulation in the Treasury, needs Gonzalez' help.

But most Fed watchers think that if the economy continues to perk along, Greenspan won't hold off beyond March. The crucial question then will be the response of the credit markets. If, as many expect, bond traders celebrate the Fed's vigilance by pushing down long-term rates, the Fed and the Administration could both win. The central bank would polish its anti-inflationary credentials. And Clinton could be rewarded with an economy that remains buoyant beyond next fall's elections--perhaps even through 1996.

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