Political Hardball Inside The Fed

Using the press, regional banks may force Greenspan's hand

The Federal Reserve prides itself on its collegiality and its sober deliberations, free of backroom politicking. When deep divisions surface, though, the Fed's monetary mandarins are not beyond playing Beltway hardball. That became abundantly clear on Sept. 17, when an extraordinary leak seeped out of the secrecy-obsessed central bank: Eight of its 12 regional banks have requested at least a quarter-point hike in the key discount rate, with three of the eight--Minneapolis, San Francisco, and Richmond, Va.--pushing for a half-point boost.

Veteran Fed watchers agree that the leak to Reuter news service was a shot across the bow from one of the hawkish regional bank presidents to Fed Chairman Alan Greenspan. Approximate translation: We want a rate increase, and we want one now. And it looks as if the maneuver will work.

RISING CONCERN. For months, Greenspan and his board of governors had resisted the hawks among the bank presidents. But Fed insiders are signaling that Greenspan and his allies are likely to beat a tactical retreat at the Fed's Sept. 24 rate-setting meeting, acceding to a quarter-point boost in both the 5% discount rate, which the Fed charges banks directly for overnight loans, and the 5.25% federal funds rate, which banks charge one another. Such a small hike "won't affect the economy," says one dove. "And if it's a mistake, we can easily undo it."

Greenspan has never been one to court confrontation. While Administration officials believe he had hoped to postpone any move until after the elections, Fed colleagues say he would not do so at the risk of a rebellion on the Federal Open Market Committee. Indeed, even before the discount-rate leak, Greenspan seemed willing to placate the hawks, who argue that higher rates are needed to head off a wage spiral caused by tight labor markets.

In recent days, for example, the Fed chief has been signaling his rising concern over pay pressures. With corporate profit margins starting to narrow, he fears that employers may be less inclined to swallow wage hikes--and under greater pressure to ram through higher prices. Adding to the wage push: an imminent hike in the minimum wage. Greenspan is mindful that the last such increase had little inflationary effect because it arrived during 1991's weak economy. By contrast, he worries, the new wage boost will only add to labor market pressures.

Until lately, Greenspan had argued that there was no sign that the wage spiral was driving up prices. Moreover, he maintained, a sizzling economy would cool by fall, making a rate increase unnecessary. But hawks feared that with unemployment running at a seven-year low of 5.1%, the slowdown could be too little and too late to prevent a new bout of inflation. The economy "is running hot," Dallas Fed President Robert D. McTeer Jr. said in a recent speech. "The pedal is to the metal."

"COUNTERATTACKED." That's not how it looked to Wall Street on Sept. 12 and 13, when government reports showed that inflation was still tame and retail sales soft. Bond and stock prices surged as traders suddenly bet that Greenspan & Co. would indeed hold off hiking rates until after the elections. That didn't sit well with the Fed hawks. Rather, Fed watchers say the frustrated regional banks feared the markets were getting complacent, and Greenspan wasn't doing anything to prepare them for a rate increase. "I think Greenspan got counterattacked by presidents who are fed up with the governors arguing that the economy has changed and the inflation risks aren't as great," says David M. Jones, chief economist at Aubrey G. Lanston & Co.

But the leak may not have been necessary after all. In recent weeks, some of the more dovish Fed governors--Janet L. Yellen, Lawrence B. Lindsey, and Laurence H. Meyer--have voiced rising concerns about wage pressures, which until now they've thought had been kept in check by global outsourcing and corporate downsizing. Although they aren't likely to lobby for a rate boost, they don't seem willing to resist one, either.

Greenspan may yet persuade his colleagues that there's no harm in waiting until after the elections to act: Inflation won't explode over the next six weeks. But Chairman Greenspan faces political peril--open dissension in the Fed. And that's a risk he's unlikely to take. Always the cautious consensus-builder, he likely will figure a quarter-point hike is a cheap price for keeping the peace.

    Before it's here, it's on the Bloomberg Terminal.