Interest rates expected to increase
By Jaivin Karnani

The recent interest rate hikes by Alan Greenspan and Company at the Federal Reserve are an attempt to rein in the record-breaking U.S. economy. The primary objective of raising interest rates is to keep inflation, or rising prices, at bay by increasing the costs of borrowing money.
The National Association for Business Economics projected in its latest economic outlook that growth of gross domestic product (GDP), the country's total economic output, will slow slightly to 3.8 percent this year, after three straight years of growth at 4 percent or more. For 2001, the group forecast an even more pronounced slowdown, with GDP expanding by just 3 percent, which would mark the slowest annual growth rate since a 2.7 percent increase in 1995.

“This slowdown in GDP growth will be the work of the Federal Reserve, which may continue to raise interest rates further,” said Harrison Cheng, Associate Professor at the Department of Economics. This comes on the heels of four interest rate increases of .25% each since June.<br /> In their last survey in November the economists expected the Fed to raise interest rates only once this year; the group now forecasts three increases, according to Michael R. Englund, a NABE (National Association for Business Economics) Outlook Writer. The first interest rate increase for the year came on February 2, raising the federal funds rate, the rate banks charge each other for overnight loans, to 5.75 percent.
Diane Swonk, president of the business economics group and chief economist at Bank One in Chicago, said "The NABE panel continues to revise up its estimates of growth for 2000. With those revisions, however, is also a shift in perspectives on the Fed. In the past, the panel believed that the economy would eventually slow on its own, with little intervention from the Fed. Today, the panel believes that the Fed will need to tighten to get the economy to slow measurably."
According to Michael R. Englund, the NABE forecast panel believes that the economy will grow 3.8 percent in 2000, but will post only 3.0 percent growth in 2001. A series of monetary policy tightenings this year is expected to more than offset the stimulative effect of an improving global economy.
Also, inflation, as measured by the Consumer Price Index (CPI), is expected to remain essentially unchanged at 2.5 percent in 2000 and 2.6 percent in 2001, following the 2.6 percent gain in 1999. This implies upside risk to core inflation in both years given the potential for an oil price correction.
“The Fed is being extremely cautious in its fiscal policy in that it may not even create a desired effect of slowing down the economy until inflation really picks up,” said Professor Richard H. Day of the Department of Economics.
NABE also expects the unemployment rate to fall slightly in 2000 to 4.1 percent from 4.2 percent in 1999, but is then expected to rise to 4.3 percent in 2001 due to a slowing economy.
“This is the trade-off that the Fed must decide to take,” said Professor Cheng. “By raising interest rates, they don’t want the economy to overheat, but they also limit the economy’s growth,” he added.
The panel also pointed out that a sudden plunge in the high-flying stock market as the greatest threat to the expansion. Professor Day stated that a major correction in stock prices will impact the economy as many people are currently using the value of the stocks they own as collateral towards things such as homes and other large finance-required purchases.
“Banks would then be unwilling to use the value of stocks as collateral, causing lending to decrease and putting further strain on the economy,” Professor Day added.
However, the recent interest rate increases have not had much of an effect in slowing the economy down, witnessed primarily by the large gains seen in technology stocks in the last four months.
“If interest rates go high enough, they may have an impact in the future, but I don’t see that happening anytime soon,” said Professor Day.