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Why rate hikes aren't slowing the economy

February 18, 2000
Web posted at: 11:12 AM EST (1612 GMT)

By Michael Eskenazi

(TIME.com) -- Like a fireman pointing a hose at a smoldering house, Federal Reserve Chairman Alan Greenspan indicated Thursday morning that he will continue trying to cool off the economy before it bursts into flames. Making his biannual Humphrey Hawkins report to Congress, Greenspan again delivered the familiar sugar -- the U.S. economic juggernaut is plowing on with no slowdown in sight -- and then the medicine: This prosperity has to be kept at a steady pace. Financial analysts take this to mean that a substantial hike in the Fed's lending rates is in order.

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"Greenspan is concerned that demand for products and services is growing at a faster pace than the economy can supply," says TIME financial writer Bernard Baumohl. "That's the formula for inflation." This rampant demand, notes Baumohl, is based largely on the success of the stock market, in which an unprecedented percentage of Americans now have a stake. "The Fed sees the stock market leading consumers to act in a way that may not be rational," he says. "Consumers check their portfolios and see gains, and spend money based on those gains before cashing in their stocks." That's the inflation side of the picture; there's also danger of an economic downturn caused by a stock market reversal. "If there's a correction," says Baumohl, "all of a sudden these consumers would abruptly stop spending, and that could send us into a recession." While the Dow Jones dropped slightly on news of Greenspan's report, the tech-heavy NASDAQ saw steady gains throughout the morning and early afternoon -- a trend at the heart of a problem for the Fed chairman. "These days the high-tech companies seem immune to interest rate hikes," notes Baumohl. "It makes it more difficult for the Fed to rein in consumer spending, because consumers are buoyant and enthusiastic because they're watching their wealth grow." But real wealth, as Greenspan knows, isn't paper stock market profits.

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