Lyle E. Gramley has a long background in Washington policy circles: three years on President Carter's Council of Economic Advisers and five years as a Federal Reserve Board governor.
After leaving the Fed, he settled down at the Mortgage Bankers Association, where he is now consulting economist.
Recently, he discussed the economy with Steve Davies, senior reporter for American Banker's sister publication, The Bond Buyer.
Q.: What kind of growth are you looking for in the U.S. economy this year?
GRAMLEY: My number is around 3.25%, fourth quarter to fourth quarter.
I would have a higher number but for the fact that I assume further measures of Federal Reserve tightening designed very deliberately to cool off the economy in order to keep inflation from worsening.
Q.: A lot of analysts see some signs of cooling in the economy and believe the Fed may pause for a long time, or may only tighten credit one more time this year.
Do you share that view?
GRAMLEY: I think the Fed Officials were signaling with their May 17 press release that they wanted to give the market a respite from further tightening actions that will last as long as the Fed safely thinks it can.
I do not expect any tightening action by the Fed at its next [Federal Open Market Committee] meeting which is July 5, but my guess is that the respite isn't going to last a lot longer than that.
I think that, by the August meeting, we're likely to see signs that the economy's growth is beginning to pick up again, and so the end of Fed tightening is not yet here.
Q.: How much more Fed tightening do you think we're going to see?
GRAMLEY: I think the fed funds rate is probably going to have to go up to somewhat over 5% by early next year to get growth slowed down to around 2.5%, which is about our long-term growth potential, and to keep it there in the face of what probably will be increased strength-from the external side during the course of 1995.
Q.: Do you think the Fed's rate increases so far this year are starting to bite?
GRAMLEY: Sure, they're having some effect.
But I would say the principal reasons for the slowdown in the economy are probably not that because the effects of higher interest rates take a while to register themselves in economic statistics-and the course of the economy.
But in the housing area particularly, you see some advance indications that monetary policy is indeed working. Refinancings have dropped Off a ton, and this is important because it will slow a source of cash to consumers.
We are also seeing in our weekly survey of applications for loans received by large mortgage bankers a rather significant' decline for loans to purchase houses.
Q.: President Clinton recently said in an interview on ABC that he would like to see the Fed hold rates steady for the rest of the year as long as there is no evidence of a pickup in inflation. Do you think he'll get his wish?
GRAMLEY: No. My guess is that the Fed will tighten monetary policy further. The argument that the Fed should hold still until inflation begins to rear its ugly head is badly mistaken.
Monetary policy works on the economy with a considerable lag and, on wages and prices, with an even longer lag If the Fed waits until inflation becomes evident, even to the politicos in the White House, it is way too late.
A.: [Fed Chairman Alan ] Greenspan has said he is aiming at 1995 in what he is doing so his actions in raising rates have been called a preemptive strike against inflation. Do you think he'll be successful?
GRAMLEY: I don't suppose that the Fed will be so successful that we have absolutely no increase in inflation in 1995. But I think they will succeed to the degree that will keep the worsening in inflation in 1995 down to quite moderate proportions.
If they do that, then we'll end up this expansion with an inflation rate that was considerably lower than the one we ended up with at the end of the expansion in the 1980s,
And that will be a very substantial degree of success.
Q.: What kind of inflation are we looking at?
GRAMLEY: My number for the [consumer price index] in 1994 is 2.9%. My number for 1995 is 3.3%. That's what I would call a very modest uptick.
Q.: Do you think this Fed tightening can actually succeed in prolonging the expansion throughout Clinton's first term and ultimately help him?
GRAMLEY: Yes, I certainly do.
Let me put it to you another way. If the Fed had sat idly by and let 'the funds rate sit at 3%, then by the middle of 1995 we would have had a roaring inflation, and they would have had to clamp down harshly, and the chances of recovery continuing through 1996 would have been minimal.
