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A lone, upbeat voice on the economy
Ex-Fed governor says economy is on track and Greenspan will hike rates 'back to neutral.'
April 18, 2005: 11:27 AM EDT

NEW YORK (CNN/Money) - If you take the stock market at face value, you'd conclude the economic sky is falling after last week's big selloff.

In the midst of all the hand wringing over the state of business, what better to consider than a very upbeat view from a former Federal Reserve governor.

Last Friday, I caught up with Larry Meyer, who was a Fed Board governor from 1996 to 2002. He told a conference of investors there's no doubt that the economy slowed from a red-hot January to a cooling off in March. And that means second quarter GDP growth will pull back to about 3 percent, which is below trend.

But he forecast a rebound in the economy because consumer spending will stay "solid," exports will pick up due to the weaker dollar and business investment will remain healthy. He sees GDP back above 3-1/2 percent in the second half of this year and more Fed rate hikes.

Now, you may recall that Larry is the Fed governor who is credited with -- or blamed for -- leading the faction at the Fed that wanted keep raising rates back in 1999 and 2000. He argued for a 50-basis point rate hike in the federal funds rate to 6.5 percent in May 2000.

(Since leaving the Fed, Larry has made it clear that nothing happens to interest rates unless the Fed chairman Alan Greenspan wants it. Therefore it's unfair to blame him for the rate hikes that coincided with a peak in the stock market and preceded a vicious bear market in stocks and a mild recession.)

Knowing where Meyer has stood, what's he think about the Fed now? If the economy is suddenly weaker than most analysts thought, then this could mean there is less pressure on inflation than many had assumed and less reason for the Fed to keep hiking rates.

But Meyer's message is clear: Don't count on it.

The Fed looks at three main guideposts, he says: the rate of growth of GDP relative to trend -- which he says is around 3.5 percent; the level of unemployment; and core inflation.

With the jobless rate at 5.2 percent, "We are on the doorstep of full employment," he said. "That gives rise to the urgency to get back to neutral on the funds rate," he told his audience at the Stephens Fixed Investment Symposium in Las Vegas.

On the inflation question, he says that the Fed is happy as long as the core inflation rate (the consumer price index excluding food and energy prices) stays in a range between 1.5 percent to 2.5 percent on a year-over-year basis. That's their "comfort zone." Right now the core CPI is running at 2.3 percent. It's not so much that big demand pressure is bubbling up in the economy but that a jump in commodity prices is having an impact.

Meyer said there's a go-slower and stop-sooner camp at the Fed right now, led by the staff economists who don't see inflation picking up, think businesses are still very cautious and are worried about the exports. This camp's view would imply that the fed funds rate be raised to 3.5 percent at the highest.

Meyer's view is that the Fed will keep hiking rates, taking them rate to 4 percent by the end of 2005 and to 4.5 percent by May of 2006. That's where the funds rate will be "back to neutral," he says, and by then the economy will be slowing back to trend.

Like the rest of us mere mortals, however, Meyer is watching the numbers to see if they bear out his faith in an economy that is basically on track and just experiencing a temporary oil-induced setback. Even he admits "it depends."

For more columns by Kathleen Hays, click here.  Top of page

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