[Congressional Record Volume 140, Number 52 (Wednesday, May 4, 1994)]
[Extensions of Remarks]
[Page E]
From the Congressional Record Online through the Government Printing Office [www.gpo.gov]


[Congressional Record: May 4, 1994]
From the Congressional Record Online via GPO Access [wais.access.gpo.gov]

 
                     INTEREST RATES AND THE ECONOMY

                                 ______


                          HON. LEE H. HAMILTON

                               of indiana

                    in the house of representatives

                         Wednesday, May 4, 1994

  Mr. HAMILTON. Mr. Speaker, I would like to insert my Washington 
Report for Wednesday, May 4, 1994 into the Congressional Record:

                     Interest Rates and the Economy

       Most Hoosiers recognize that the economy is doing better 
     now than it has in many years. Yet the recent actions by the 
     Federal Reserve to raise interest rates have increased 
     concerns about the outlook for the economy. I am frequently 
     asked why the Fed raised interest rates when unemployment is 
     still too high and there are no signs of inflation, and how 
     the Fed's actions will affect the job outlook and family 
     finances for Hoosiers.


                              The Economy

       Many people wonder why the Fed wants to slow the economy 
     just when it finally appears to be strengthening. The U.S. 
     economy got progressively stronger throughout 1993 and grew 
     at a 7.0% rate during the final quarter, the fastest growth 
     in a decade. The economy grew at a 2.6% rate during the first 
     quarter of 1994, and analysts expect continued growth of 
     about 3.0% this year. There has also been a welcomed pick-up 
     in job growth. Since January 1993, the economy has created 
     2.5 million new jobs, double the rate in 1992. These jobs 
     have almost all been in the private sector, including more 
     manufacturing jobs after years of losses. In Indiana, more 
     than 20,000 jobs were added during the past year, including 
     7,000 jobs in manufacturing. The Indiana unemployment rate in 
     February was 5.0%, down from 5.7% a year ago, and a full 
     point and a half less than the national rate of 6.5%. Growth 
     in income per person is also doing better, and that has 
     helped push consumer confidence to a five-year high.
       Much of the strengthening of the economy is linked to the 
     reduction in the federal budget deficit, and the resulting 
     lower interest rates. Last year, Congress enacted a major 
     deficit reduction package that will reduce the projected 
     federal deficit by some $430 billion during the next five 
     years. Spending was cut for more than 500 programs. In 
     relation to the nation's output, the deficit in 1995 will be 
     the lowest since 1979.
       Fed decisions to hike interest rates are closely linked to 
     a fear of impending inflation. For the past three years, the 
     inflation rate has been declining and most analysts expect 
     little or no increase in inflation in the foreseeable future. 
     The 2.7% rise in prices in 1993 was one of the lowest in 30 
     years. Analysts cite a number of reasons why they think 
     inflation will remain under control, including the impressive 
     recent rise in productivity, the large pool of available 
     workers, worldwide excess capacity in many industries, and 
     competition from foreign products.


                              Fed Actions:

       Interest rates, particularly long-term rates, can 
     strengthen or weaken economic growth since they affect 
     business investment decisions and major household purchases. 
     The Fed can directly influence the direction of short-term 
     interest rates, such as the rates on savings accounts or 
     automobile loans. But long-term rates, such as the rates on 
     home mortgages or corporate borrowing, are determined largely 
     by private sector and government demand for long-term loans 
     and by the outlook for inflation.
       During 1993, the Fed kept short-term interest rates at a 
     30-year low. At the same time, long-term interest rates 
     declined to their lowest levels since the late 1960s, and 
     that helped boost the economy, particularly by the fourth 
     quarter. This year, with the economy growing and the 
     unemployment rate falling, the Fed has responded by raising 
     interest rates three times since early February. Its purpose 
     is to brake lightly the economy's recent acceleration and 
     ensure that there will be no significant rise in 
     inflation. The question is whether the Fed is over-
     reacting to a decline in unemployment. It appears to be 
     convinced that the inflation danger is imminent. Many 
     disagree.
       Certainly at some point unemployment will fall so low that 
     there will not be enough people for all the jobs employers 
     want to fill. At that point enterprises will compete for 
     workers by bidding up wages, and that will accelerate 
     inflation. Some economists argue that unemployment can fall 
     to 7 million people before a shortage of workers begins. The 
     Fed thinks the key point is 8 million, and as unemployment 
     has fallen toward that level it has acted.
       While I do not criticize the Fed at this point, my instinct 
     is that we should favor jobs at least as much as fighting 
     inflation. The risk is that when the Fed decides to use tight 
     money to fight inflation it may succeed at holding inflation 
     down but it can also generate a real slump and put people out 
     of work.
       Before he started raising short-term rates to control 
     inflation, Fed Chairman Greenspan testified that a rise in 
     short-term rates would have only a small effect on long-term 
     interest rates and could eventually bring them down. I 
     supported the Fed's initial increase on that basis. But long-
     term rates have risen much more than anyone anticipated. The 
     rates on home mortgages and corporate bonds have gone to 
     their highest level in two years. Since moderate long-term 
     rates are essential for sustained economic growth, the recent 
     rise is a matter of concern. Many households will have to pay 
     more interest on their home equity loans and credit cards, 
     and interest costs for businesses will also rise. This may 
     slow the economy.
       I support the independence of the Fed and respect its 
     judgment. The Fed believes the increase in rates will be good 
     for the economy, but it will be some time before we know 
     whether it was the right thing to do. At the moment, I am 
     concerned that the Fed has not done a very good job of 
     explaining why it raised interest rates and what it hopes to 
     accomplish, particularly since long-term interest rates have 
     behaved so differently from what it expected. At a time when 
     unemployment is still higher than most of us would like and 
     there are no signs of rising inflation, Congress and the 
     American people need to understand what the Fed is doing. 
     Before they proceed with additional interest rate hikes, Fed 
     officials should testify before Congress to give a full 
     accounting of their recent actions.


                               conclusion

       Without doubt we have to recognize the critical need to 
     remain vigilant against inflation, and I do understand that 
     the Fed is trying to change the psychological atmosphere in 
     the financial markets. What bothers me is that the specter of 
     inflation--not the fact of inflation--is governing the speed 
     at which the economy can grow.
       The building blocks for sustained expansion--including 
     smaller deficits, improved productivity, and strong 
     investment--are increasingly in place. The U.S. economy is 
     well positioned to experience a long phase of steady growth 
     and only modest inflation. The delicate task of economic 
     policy at the moment is to throttle inflation but not the 
     expansion.

                          ____________________