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Fed Governor Sounds Warning

Economy: He says board may have to raise rates to prevent overheating if Asia's crisis doesn't do it.

April 22, 1998| From Reuters

WASHINGTON — The Federal Reserve Board will raise interest rates to prevent the world's top economy from overheating unless Asia's crisis dampens the frenzied pace of growth soon, Fed Governor Roger Ferguson said Tuesday.

In an interview, Ferguson said domestic demand and the labor market has been so strong since the start of the year that a rise in inflation, rather than a slowdown in the rate of growth, now poses the main danger to the U.S. economy.

"Either Asia will slow the economy to something that is more sustainable or there will have to be some Fed action that will do that," Ferguson said.

"We are clearly above anybody's expectation of what a reasonable growth trend is. We may be in a position where we have above-trend growth which is unsustainable," he added.

His remarks jolted financial markets. Investors said they indicated mounting concern among Fed board members about the relentless pace of growth in the U.S. economy, which could prompt the central bank to raise credit costs before too long.

The Fed has held interest rates steady for more than a year, and the key overnight federal funds rate stands at 5.5%. Its rate-setting council next meets on May 19.

Ferguson, who joined the Fed board last November after a 13-year career as a banking consultant, said policymakers are eyeing data to be released over the second quarter of the year for "a clearer picture" of economic conditions. But he noted that, at least so far, the impact of Asia's turmoil on the U.S. economy has been moderate.

Analysts on average expect the economy to have grown by 3.3% in the first quarter, after clocking a fiery 3.8% for all of 1997.

Characterizing such growth as "probably unsustainable by any reasonable measure," Ferguson warned: "The risk we face now is that Asia will slow us down less than we thought. The risks have moved from being balanced to perhaps being tilted toward the upside."

The Fed last December dropped a bias toward raising rates, adopting a neutral policy stance of keeping rates on hold. The move reflected a belief among most policy-makers then that the risks to the economy were balanced, requiring the Fed to keep all its options on the rate front open.

With consumer prices rising at a meager 1.4% from the same time a year ago, Ferguson said the U.S. economy may well be headed toward price stability. Stable prices and maximum employment together form the Fed's twin mandate. But he warned that it is crucial to "hold on to that victory," particularly since many of the factors helping to keep inflation low may not last forever.

"You don't have overheating showing up just yet because there are special factors holding down inflation," he said. He did not specify the factors, but policymakers have previously cited the firm dollar and low commodity prices as contributing to low inflation and strong growth.

The central banker said recent labor market and industrial production data had indicated a somewhat slowing pace of growth, but he cautioned that the numbers were influenced by one-time factors such as mild winter weather.

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