Fed Suggests Past Won't Be a Guide for Its Moves

By EDMUND L. ANDREWS
NY Times

WASHINGTON, June 2 - If Alan Greenspan has his way, the Federal Reserve will raise interest rates much more slowly than in the past. The question is whether his hand will be forced by rising inflation.

Mr. Greenspan, the chairman of the Fed, noted in a May 14 letter to Senator Paul S. Sarbanes, Democrat of Maryland, that the central bank raised short-term rates fairly sharply when it moved to curb higher inflation in 1988 and 1994, and more modestly in 1999. The letter became available on Wednesday.

But Mr. Greenspan emphasized in the letter that the past is no guide to the future because consumer prices are climbing much more slowly today and are likely to continue to do so.

Based on a tidal wave of data showing strong economic growth, a surge in job creation and new hints of inflation, most analysts predict that the Fed will start to raise rates at its policy meeting on June 29 and to keep raising rates gradually over the next year or so.

Mr. Greenspan and other top monetary officials have made it clear since April that they will have to retreat from their policy of cheap money sooner rather than later, but they have also reassured investors by insisting that any rate increases would be gradual and "measured."

But after four years in which rock-bottom interest rates have stoked a boom in home building and home refinancing, the big unanswered question is how far rates will have to rise before monetary policy becomes "neutral," neither fueling inflation nor slowing down economic growth.

"The current highly accommodative stance of monetary policy must be returned to a more neutral setting," Mr. Greenspan acknowledged in his letter, which was a response to questions posed by Mr. Sarbanes at a hearing of the Senate Banking Committee last month.

However, he continued, "The current backdrop of low inflation and underutilized resources suggests that the transition to a more neutral policy stance can be undertaken at a pace that is likely to be measured."

The current "real" federal funds rate for overnight loans between banks, adjusted for inflation, is actually below zero and is much lower than normal. Historically, the federal funds rate has averaged about 2.7 percentage points above the rate of inflation, and it rose much higher than that when the central bank was fighting back double digit inflation in the late 1970's.

Mr. Greenspan and other top officials have repeatedly argued that inflation is likely to remain low for the foreseeable future, in part because unemployment remains relatively high at 5.6 percent and because productivity is still rising much more rapidly than in the past.

But hints of faster inflation have been multiplying in the last two months, and a growing number of analysts worry that the central bank has been too slow to grasp their significance. Commodity prices, though somewhat lower in the last two months, have soared in the last year. Wholesale prices have been climbing more sharply than expected, and prices for many consumer goods have started to climb as well. For the first time in years, many business executives are saying they can pass higher energy and material costs through to consumers.

Ian Shepherdson, chief United States economist at High Frequency Economics, a forecasting company, recently urged the Fed to raise the federal funds rate by half a percentage point at its next policy meeting, though analysts predict that the Fed will begin with a quarter-point increase and follow with a gradual series of increases over the next year.

But William C. Poole, president of the Federal Reserve Bank of St. Louis, said in a recent interview that Mr. Greenspan was probably right to be fairly sanguine about inflation.

"We still have a margin of unused market capacity, and most observers believe there is still unemployment that needs to be absorbed," Mr. Poole said. "I don't believe the markets feel we are behind. If they did, we would see a lot more signs of people anticipating higher inflation. I just don't see the evidence."

Fed officials acknowledge that the most important issue may not be inflation itself as much as people's inflationary expectations. The University of Michigan's April survey of consumers showed that they expect prices to rise 3.2 percent over the next, which is more than the Fed expects.

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