Good economic times will continue, but interest rates will creep up

August 13, 1999

ANN ARBOR—While good economic times for America should continue into the new millennium, increasing signs of rising inflation will cause the Federal Reserve to tighten monetary policy and raise short-term interest rates, say University of Michigan economists.
“The recent and prospective inflation situation causes reason for concern,” says Saul H. Hymans, U-M professor of economics. “In all likelihood, we’ve passed the bottom of the inflation cycle.
“The special benefits we received from sluggish economic behavior in other parts of the world may be about over and the tight U.S. labor market may well be starting to exert some upward pressure on the price level. It wouldn’t be at all unexpected at this point if the Federal Reserve were to decide that monetary policy needed to tighten.”
In fact, Hymans and colleagues Joan P. Crary and Janet C. Wolfe expect the Fed to gradually raise short-term interest rates over the next several months, beginning with an increase at its next meeting Aug. 24 (coming on the heels of a quarter-percent increase at the end of June).
In their annual mid-year review and forecast of the U.S. economy, the U-M researchers predict that the federal funds rate (which influences many interest rates that affect consumers) will rise from a current mark of 5 percent to 5.75 percent by the end of this year, holding steady at that rate through 2001.
As a result, they expect the conventional home mortgage rate (7.6 percent in Despite the predicted rise in interest rates, the pace of inflation is expected to move from the low rates of 0.8 percent in 1998 and 1.7 percent in 1999 to higher, but still moderate, rates of 2.6 percent next year and 2.4 percent in 2001.
Overall, Hymans and colleagues say that economic growth will slow from this year’s 3.7 percent rate to 2.5 percent in 2000 and to 2.4 percent in 2001. Unemployment, meanwhile, is expected to edge upward from a current rate of 4.3 percent to 4.6 percent in 2001.
“Moderate growth forecast for the remainder of 1999 and early 2000 is followed by an even slower rate of expansion of U.S. output in the second half of next year,” Hymans says. “After making positive contributions to output growth from mid-1999 to mid-2000, the pace of inventory building backs off in the second half of 2000, contributing to a deceleration in the rate of real GDP growth during the second half of next year.”
The U-M forecast, based on the Michigan Quarterly Econometric Model of the U.S. Economy and compiled by the U-M Research Seminar in Quantitative Economics, also predicts that:

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