The Federal Reserve Board is located about 2 miles down Constitution Avenue from Capitol Hill, but in the coming months this short stretch of road could become one of the meanest streets Main Street has ever seen. Last week, just seven days after Newt Gingrich and the Republicans took control of Congress promising sharp cuts in almost every government program except defense, Alan Greenspan's Federal Reserve raised two key short- term interest rates by .75 percentage points. The Fed's apparent goal is to slow economic growth from its current 3.4 percent rate to approximately 2.5 percent.
Many inflation-wary bond and currency traders on Wall Street applauded the move, but a growing number of analysts warned that the interest rate increases will hurt future employment growth. Max Sawicky and Dean Baker of the liberal Economic Policy Institute in Washington estimate that if the Fed reduces growth by about 1 percentage point, 1.3 million to 1.4 million jobs could be lost in a year. The six rate hikes since February, add economists, have already begun to take their tollon middle and lower income groups -- through higher debt costs and less affordable housing.
Increased deficits. The pain could deepen for many of these Americans if Republican proposals to cut entitlement programs become law. In addition, the GOP's tax-cut plans could boost the federal government's deficit by $30 billion to $40 billion above current projections by 1999, according to preliminary estimates by the WEFA Group in Bala-Cynwyd, Pa. While many Republican policy makers believe that cutting federal income and capital- gains taxes will lead to more -- rather than less -- tax revenue, most economists calculate that these proposals will actually reduce federal revenues and increase the deficit. If the deficit starts spiraling upward as it did during the Reagan years, when tax cuts were last in fiscal vogue, real interest rates could surge even higher. Ultimately, asserts Alice Rivlin, director of the Office of Management and Budget, this chain of events could land the economy in recession.
Right now, however, Wall Street is much more concerned about inflationary threats that could erode the value of financial assets than the prospect of an economic downturn. The Fed sees potential inflationary pressure in rising employment and industrial output that it believes is bumping up against plant capacity. But it is raising interest rates today even though there is scant evidence of the wage pressures that have led to sustained inflation in the past. The unemployment rate has been hovering around 6 percent for several months, yet unit labor costs have been falling in manufacturing and rose just 0.2 percent in the third quarter in the overall business sector. Last week, a day after the Fed pushed up interest rates, the government reported that consumer prices in October increased a paltry 0.1 percent. WEFA's Daniel Bachman points out that most of the jobs being created now are in white-collar occupations, where unemployment remains high by historical standards. This further reduces wage pressures. Bachman also argues that labor tightness in some lower-skilled occupations, such as hospital and food services, may be exaggerated. The reason: There are additional workers available for those jobs because of illegal immigration.
The hardest hit. While the Fed is expected by Wall Street to focus on the specter of inflation, the central bank's policies often come at the expense of middle- and lower-income Americans. Rising interest rates hurt these citizens disproportionately through employment and wage losses. These people are also hit hardest by higher debt costs, while benefiting least from financial assets. New York University's Edward Wolff reports that the top 7 percent of households own 60 percent of bonds and 31 percent of all other interest-bearing assets. This means that the bulk of bond income from an increase in interest rates flows to the wealthiest families in the country. In contrast, the cost of higher interest rates on loans falls most heavily on those families who earn less than $50,000 a year, since their debt payments as a percentage of income are higher than those who earn $50,000 or more.
The Fed's interest rate increases are already showing up in the housing market, the most interest-rate sensitive of all industries. Thirty-year fixed-rate mortgages have jumped from 6.83 percent in October 1993 to 9.2 percent today, and in October housing starts for single-family homes dropped 7.4 percent from the previous month. David Lereah, chief economist of the Washington-based Mortgage Bankers Association, predicts that the 30-year fixed rate will rise to about 10 percent next year, cutting large numbers of potential buyers out of the market. And the National Association of Realtors reported last week that the income needed to qualify for conventional financing on a starter home has risen to $29,895; but the median income of first-time buyers is just $24,811, one reason why analysts expect a contraction in home sales next year.
Home refinancing activity spurred by falling interest rates in 1992 and 1993 lowered consumer debt service by an estimated $30 billion. Homeowners either saved this cash or put it toward the purchase of appliances, furniture and cars. Now many consumers have to dip into savings to purchase these big-ticket items. And rising rates could soon deter potential car buyers, a factor that could crimp auto sales late next year. This means that demand for consumer durables will drop, ultimately hurting employment in this sector of the economy. Last week, for example, Whirlpool announced the layoff of about 800 American workers.
These job losses could be the harbinger of harder times, and if the current economic expansion falters, many middle-class Americans could become even more disillusioned with Washington -- if that's possible.
Cheap labor Labor costs, which represent about three quarters of production costs, remain in check because of rising productivity.
Percent change in unit labor costs for manufacturing
1992 Q1 0.2 pct.
1992 Q2 0.0 pct.
1992 Q3 1.2 pct.
1992 Q4 0.6 pct.
1993 Q1 - 0.3 pct.
1993 Q2 0.0 pct.
1993 Q3 - 0.3 pct.
1993 Q4 - 1.6 pct.
1994 Q1 - 0.9 pct.
1994 Q2 - 2.9 pct.
1994 Q3 - 3.8 pct.
Note: Figures are change from same period a year ago. USN&WR -- Basic data: U.S. Department of Labor
The big squeeze High interest rates are putting pressure on many middle-class families, as housing affordability declines and cash from home refinancings dries up.
Family debt payments as share of family income
1989 1992
$100,000 or more 16.5 pct. 11.8 pct.
$25,000-$49,000 16.8 pct. 19.7 pct.
Less than $10,000 13.2 pct. 16.0 pct.
USN&WR -- Basic data:Federal Reserve Board
Housing affordability index
1993 Q1 132.5
1993 Q2 133.1
1993 Q3 135.9
1993 Q4 141.9
1994 Q1 140.6
1994 Q2 131.3
1994 Q3 127.8
Note: A drop in the afforability index means fewer people can purchase homes USN&WR -- Basic data:National Association of Realtors
Mortgage application volume index for refinancing (March 1990=100)
09/93 1,670
10/93 1,349
11/93 893
12/93 646
01/94 941
02/94 777
03/94 480
04/94 233
05/94 161
06/94 144
07/94 119
08/94 121
09/94 102
10/94 96
11/94 93
Note: Refinancing figures are for end of month, except November 1994, which is latest available data.
USN&WR -- Basic data:Mortgage Bankers Association of America
