WASHINGTON – Conflicting economic risks that could emerge from Hurricane Katrina are putting Federal Reserve Chairman Alan Greenspan and his central bank colleagues in a challenging spot.
Fallout from the disaster is expected to slow economic growth over the rest of the year, perhaps persuading the Fed to suspend its campaign of raising interest rates.
But a main argument for the Fed to stay the course is the concern that high energy costs, made worse by the killer storm, could filter down and affect the price of all kinds of things. Broader inflation could follow.
Policy-makers meet Tuesday to consider their next move on interest rates. Many economists are betting they will lift an important short-term benchmark by one-quarter of percentage point, to 3.75 percent.
It would be the 11th such increase since the Fed began to tighten credit in June 2004.
Commercial banks would be expected to increase their prime lending rates by a corresponding amount, to 6.75 percent. These rates are used for many short-term consumer loans, including some credit cards and popular home equity lines of credit.
If the Fed pushes rates up again this week, borrowing costs would reach their highest level in four years.
"I think this is very, very tough for the Fed. There's also the compassion issue. You run the risk of looking very callous by raising rates," said Brandeis University economics professor Stephen Cecchetti.
When all the risks are weighed, though, Cecchetti predicts the Fed will nudge rates higher.
Those in the rate-raising camp make this case: From an economic standpoint, inflation is more dangerous now than is the threat of a serious economic slowdown.
Other analysts say the prospects of a downturn are more of a risk. They say the Fed should leave rates alone on Tuesday.
"I think the greater risk is that higher energy prices will cause consumers to pull back, slowing overall economic growth," said economist Kathleen Camilli, president of Camilli Economics. She is on the side of those who think the Fed will leave rates unchanged at its meeting.
Whatever the fate of interest rates, there is agreement that the hurricane shaping up as the costliest natural disaster in U.S. history is causing uncertainty about the economic outlook. That is complicating the Fed's job of keeping the economy and inflation on an even keel.
Before Katrina, it seemed certain the Fed would raise rates at the September meeting. The idea of a pause cropped up among economists soon after Katrina struck in late August.
Given more time to assess the situation and the economic fallout, many analysts have returned to the rate-raising camp.
"Right after Katrina it looked like a no-brainer. Uncertainties about where things were going as a result of Katrina would force the Fed to pause. But since then, the idea of the Fed pausing is fading," said Charles Dumas, chief economist for Lombard Street Research Ltd.
The economy is resilient and is expected to bounce back from what many economists hope will be a temporary rough patch.
For now, Katrina is expected to reduce overall economic growth in the second half of this year by as much as one percentage point.
High energy prices are seen crimping consumer and business spending, vital ingredients for healthy economic activity. Hiring will slow. A reduction of 400,000 jobs over the next four months is forecast.
President Bush wants Congress to approve a massive reconstruction program for the Gulf Coast. The federal government's costs could reach $200 billion or more. Congress already has approved $62 billion.
Rebuilding, once under way, should help energize overall economic activity and the jobs climate, though probably not until next year.
There are mixed opinions on what the Fed will do on Nov. 1 and Dec. 13 - the last scheduled meetings for this year.
Economists will scrutinize the Fed's brief statement, released after its meeting Tuesday, for clues about the future course of interest rates. The statement explains the Fed's action and assesses economic conditions.
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