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. Last Updated: 07/27/2016

High Demand Seen Pushing U.S. Fed




NEW YORK -- If Federal Reserve policy-makers are worried that easy money is driving U.S. consumers to perilous excess, they will find little solace in the following example.


An Illinois father bought his son a $157,000 house near his high school just so the 17-year-old would have a convenient place to park, the Chicago Tribune recently reported.


Wall Street economists say such freewheeling consumer spending f fueled by cheap borrowing costs, plentiful jobs, and ballooning stock market wealth f will prompt the Fed to take a preemptive strike against inflation this week.


"It all comes back to consumers," said Christopher Low, chief economist at First Tennessee Capital Markets.


"It's excessive consumption that's feeding the demand that leads to [tight] labor markets," he said. "The Fed has got to slow consumer spending."


The policy-setting Federal Open Market Committee meets Tuesday and Wednesday, and is expected to announce a modest increase in the key federal funds rate to 5 percent from the current 4.75 percent.


Some Fed officials are concerned that the central bank's three rate cuts last fall have made it too easy for consumers to splurge on credit purchases of everything from homes to luxury cars to refrigerators.


Consumer spending rose 6.7 percent in the first quarter. Private domestic demand has been growing at a 6.5 to 7 percent rate for the past five quarters, a rate that some Fed officials deem excessive.


"There is a danger that this strong demand is being fueled by expansionary monetary policy," Richmond Fed President Alfred Broaddus said earlier this month.


In the case of the father who bought his son a home for parking, the family paid for the property with a second mortgage on their much larger home in the Chicago suburb, taking advantage of low interest rates.


And there are plenty of other anecdotes to make Fed officials wary that the ease of obtaining credit is driving consumers to gluttony f such as car dealerships reporting wealthy customers are buying a third luxury car for the family nanny.


Despite the fears that continued heavy consumption and low unemployment will eventually drive up prices and wages, the Fed has little evidence of price pressures so far.


Inflation measured by the Consumer Price Index was running at a modest 2.1 percent annual rate in May. But the Fed sees a confluence of factors likely to drive up future prices.


Weak demand for U.S. exports due to the economic crisis overseas, rock-bottom commodity prices and increasing productivity of the U.S. work force have served as safety valves, keeping the pressure off inflation in the face of ravenous consumer spending over the past few years.


But now that beleaguered economies in Asia are emerging from crisis, demand for U.S. exports should pick up and add to growth. Commodity prices are on the rise. And productivity is not likely to continue expanding so rapidly.


"What they [the Fed] are going to talk about is the tightness of the labor markets and signs that demand is exceeding income," said J.P. Morgan economist Marc Wanshel.


Fed Chairman Alan Greenspan, in his most recent testimony to Congress, signaled a rate hike by stressing its easier to battle inflation with "preemptive" monetary policy than to try to beat it back after price pressures have begun to emerge.


Although some Fed-watchers had speculated Greenspan had abandoned a preemptive policy, a move Wednesday would put that talk to rest.


A more likely explanation, said Wanshel, is that the Fed found it difficult to take any early action when it saw equal chances of recession and overly rapid growth that can lead to inflation.


"When you can clearly identify the direction of risk, that enables you to be pre-emptive," Wanshel said.