Live

Watch CBSN Live

Fed Expected To Boost Rates

A pending change at the top of the Federal Reserve is not likely to alter the game plan for combating inflation, steadily increasing interest rates.

Federal Reserve Chairman Alan Greenspan will be presiding at one of his last meetings when Fed policy-makers gather on Tuesday. It is widely expected that he and his colleagues will do what they have done for the past 11 meetings, boost a key interest rate by a quarter-point, to 4 percent this time.

And many believe the increases will continue under Ben Bernanke, President Bush's choice to replace Greenspan on Feb. 1. His Senate confirmation is likely later this month.

"The new chairman will want to show his inflation-fighting mettle," said Mark Zandi, chief economist at Economy.com. "Early on, Chairman Greenspan was on the aggressive side to establish his credentials."

Indeed, Greenspan, worried about inflation, got his colleagues to agree to boost a key interest rate by a half-point the first month after he took over as Fed chairman in August 1987. It was the first increase in the Fed's discount rate in more than three years.

Bernanke made a point of stressing after his nomination was announced that his "first priority will be to maintain continuity with the policies and policy strategies established during the Greenspan years."

People who know both men say that will not be hard, given the close working relationship the two had when Bernanke served from 2002 to June of this year as a Fed board member.

"Greenspan and Bernanke are very much on the same wavelength," said David Jones, author of four books on the Greenspan Fed.

Bernanke's early impact will not be as dramatic as Greenspan's first half-point rate hike since the central bank has been raising interest rates since June 2004.

And not all analysts believe that Bernanke will make further rate increases his first order of business. A lot will depend, they say, on where rates are in November.

The Fed is widely expected to raise its target for the federal funds rate by another quarter-point at Tuesday's meeting. That would push the funds rate, the interest that banks charge each other, from 3.75 percent, where it has been since the last meeting on Sept. 20, to 4 percent. When the Fed started raising the funds rate in June 2004 it stood at a 46-year low of 1 percent.


A number of Fed officials have openly worried about the potential threat of rising inflation. The Fed's most recent survey of the economy, the Beige Book, noted that prices were increasing for everything from lumber and hardware to hotel rooms.

Also, the Labor Department reported that consumer prices in September shot up by 1.2 percent, the biggest one-month increase in a quarter-century, led by a record rise in energy prices, reflecting the impact of hurricane-forced production shutdowns along the Gulf Coast.

"There is a risk that energy could break out into a bigger inflation problem," said David Wyss, chief economist at Standard & Poor's in New York. "We have gotten through Katrina and oil prices have backed off a bit, but there is a risk that if we have a harsh winter, energy prices will rise again."

While there is agreement about the Fed's action this week, analysts are somewhat split on what will happen next. One camp believes the Fed will boost rates again at the December meeting and the Jan. 31 meeting, which will be Greenspan's last.

That would put the funds rate at 4.5 percent, a point where the Fed may feel it has reached the "neutral" level it has been seeking. That is the point where interest rates are not stimulating extra economic growth or acting as a drag on the economy.

Wyss, however, says that in the past Greenspan has liked to punctuate a long tightening cycle by making the final rate increase a bigger half-point. If the Fed does that in December, it could well take a breather at the January meeting.

Other analysts said the Fed might leave the final rate increase for a Bernanke-led central bank, in part to allow him to demonstrate his inflation-fighting capabilities.

Still other economists believe, however, that the Fed will not pause until it pushes the funds rate as high as perhaps 5 percent early next year, especially if inflation pressures continue to mount.

"The risks are clearly that inflation will accelerate further because of energy," Zandi said.