Interest-rate brake may grab just at election time

The Federal Reserve is entering the political zone.

By raising interest rates by one-half of a percent this week - a kind of interest rate shock treatment - the Fed is expected to begin to slow the economy down at about the time voters go to the polls in November. The unemployment rate - the most politically visible sign - will likely be edging up.

The most immediate impact will be for people hoping to cash in on the American dream - owning a home. Many could be priced out of the mortgage market, and others may put off buying.

This is already beginning to build concern among some members of Congress and is being closely watched by both political camps.

If the economy were to slow substantially - something many economists don't anticipate - Vice President Al Gore could be the target of voters' frustration. "If things slow down dramatically, indirectly he will be blamed.... It's his watch," says Robert MacIntosh of Eaton Vance Management in Boston.

So far, politicians have tried to remain neutral about the six Fed rate hikes this year. On Tuesday, President Clinton said he did not think the hikes would hurt Mr. Gore and added, "I am going to let them make whatever decision Chairman Greenspan and the others think is warranted."

Although Texas Gov. George W. Bush had no immediate comment on the rate hikes, a spokesman, Ari Fleischer, says a slowing economy "reaffirms the importance of the tax cut [a Bush proposal] as an insurance policy." Mr. Fleischer notes that any tax cut would not go into effect until the fall of 2001 or early 2002.

Most economists expect the Fed to raise interest rates for a seventh time in June and perhaps again in August. The Fed implied as much in its statement after it raised rates.

Those rate increases, if they happen, will also act to brake the economy as the election approaches.

According to Cardweb.com, which follows credit-card trends, the latest rate increase will cost Americans $1.4 billion over the next year.

"Real interest rates are now at levels that have never failed to slow economic growth in the past," says Bruce Steinberg, chief economist for Merrill Lynch & Co. in New York.

By the time the election arrives, the slowdown will be starting. The first sector of the economy to feel the crunch will be housing. Mortgage rates are currently about 8.5 percent. By November, predicts David Seiders of the National Association of Home Builders, mortgage rates will be hitting 8.8 percent. "The Fed wants to slow housing down. They are not happy with how much housing prices are rising," says Mr. Seiders.

The effect on consumers will be more subtle. For example, the monthly payment on a $20,000 car will increase by $5 if the loan goes to 9 percent. Few consumers will actually pay that, however, as many car companies are offering 5.9 percent financing.

The Fed is also concerned about the tight job market. Higher interest rates will cause some additional unemployment - one of the goals of the Fed's move.

By November, however, economists expect the unemployment rate will only rise to 4.3 or 4.4 percent, up from its 30-year low of 3.9 percent today. "The job market is so tight that people are hoarding workers," says Seiders.

How will the higher costs and slower economy shake out with the voters? So far, it's not enough to hurt the Democrats, says David Wyss, chief economist for Standard & Poor's DRI. DRI's political model , which tries to meld the political and economic, predicts that Gore will win with 51.3 percent of the vote. "The basic idea is that people vote their pocketbooks," says Mr. Wyss. "The election depends on how people see their income growing and inflation."

Wyss says the only caveat in the model is a stock market crash. A sharp market tumble could undermine consumer confidence, which is quite high at the moment. Normally, rising interest rates are not good for the stock market. But after the Fed hiked rates on Tuesday, the Dow Jones Industrial Average closed up 126.79 points, helped by a report that showed consumer prices were unchanged in April.

The DRI political-economic model has been wrong twice since World War II. It picked Hubert Humphrey to beat Richard Nixon in 1968 and Gerald Ford to beat Jimmy Carter in 1976. In both cases, noneconomic matters became more important to voters.

Fed watchers usually maintain that the nation's central bank ignores politics. "They usually do what they need to do irrespective of when an election is," says Mr. MacIntosh. "They are not supposed to be political."

But the Fed members are not naive. The institution usually tries to avoid becoming the subject of political debate.

"Normally it tries to stay low during the middle of the campaign," says Sung Won Sohn, chief economist for Wells Fargo Bank in Minneapolis.

For this reason, economists expect the Fed to stop raising interest rates in August, no matter what the state of the economy.

(c) Copyright 2000. The Christian Science Publishing Society