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IMF urges Fed to up interest rates again

July 31, 2000

MOST directors of the International Monetary Fund's executive board have urged the US Federal Reserve to raise short-term interest rates again to hold inflation in check.

Last Friday, the IMF concluded its review of the US economy, finishing off with an unequivocal message that another interest-rate rise could be justified to keep inflation under control.

The recommendation came against a backdrop of unprecedented US economic expansion, which is nearing its 10th consecutive year. Real GDP grew by 4.25 per cent in the first half of last year, expanding to 6.5 per cent in the second half of the year before slowing slightly in the first quarter of this year to 5.5 per cent, according to the IMF.

The spectacular growth has fuelled consumption and investment, raising concerns over price and wage pressures. Although core inflation has been largely subdued due to gains in labour productivity and weakness in non-oil import prices, the core consumer-price index increased by 2 per cent last year and early this year. After rising sharply in March, core inflation settled back down to 2 per cent during the second quarter of this year.

But the IMF's executive board noted that a further rate rise to stem inflationary pressure "will depend on how the economy responds in the period immediately ahead to the restraining effects of monetary policy actions already in the pipeline, and if any additional indications of wage and price pressures emerge".

Alan Greenspan, the chairman of the Federal Reserve Board, will chair a crucial meeting on August 22 to determine whether any further action is needed to tighten monetary policy. The Fed has raised short-term rates six times since June last year to the present level of 6.5 per cent, hoping to engineer a soft-landing for the overcharged US economy.

At this juncture, the US is facing a dilemma of keeping the economy expanding on the back of subdued price pressures. But the IMF's directors noted that it is now generally recognised that domestic demand growth is growing in excess of productivity increases in potential output and that this process is not sustainable and needs to be slowed.

"While monetary policy tightening in the US has inevitable potentially adverse spillover effects on the rest of the world, the impact would be even more detrimental if US authorities delay policy action and subsequently tighten monetary policy more sharply once inflation pressures strengthen," the IMF's directors said.

With this IMF assessment, emerging markets, including Thailand, may have to prepare to face another round of volatility. Already, the Thai stock market, which has been moving along with regional trends, has lost more than a third of its value since the beginning of the year, closing at 291.6 on Friday. The baht, which has also moved along with the same regional forces, has fallen to a 10-month low, plunging to 41.3 at one trading session last week.




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