Strong Economy Could Weaken Clinton, Analysts Say : Politics: Some believe that President’s success has led to higher interest rates as election nears. Others question Administration’s role in the recovery.

WASHINGTON —  In October, 1993, long-term interest rates fell to their lowest level in more than a decade and the Clinton Administration hailed the decline as proof that the President’s economic program was paying off.

What a difference a year can make. No sooner had long-term rates bottomed at 5.79% on Oct. 15, 1993, than they reversed course and began climbing again.

This week they broke through the 8% barrier, the highest levels for 30-year government bonds since May, 1992, erasing all of the gains achieved since Clinton took office and threatening to slow the nation’s economic recovery.

What’s more, the timing of the long upward march of interest rates is especially awkward for the President and his Democratic allies because critical congressional elections are just two weeks away and the Clinton economic record is under intense scrutiny.

Voters appear to be in no mood to give Clinton any credit for the economy anyway, so a sharp rise in borrowing costs for homeowners and other consumers with variable-rate loans certainly will not make them any more sympathetic to the President.

But the irony is that Clinton seems to be a victim of his own success. Economists and other analysts argued that interest rates are rising simply because the economy is growing more rapidly, increasing the nation’s demand for credit, a trend that has forced the Federal Reserve to raise interest rates five times this year.

Clinton’s deficit-reduction agreement helped bring about lower rates, accelerating the pace of a lackluster recovery and providing more-rapid job creation in interest-sensitive sectors such as the auto industry and home construction.

And today, rates are probably lower than they otherwise would be if the Administration had not pushed through its economic plan last year.

“I think Clinton deserves some of the credit because now rates are up for the right reason, which is that we are at or close to the peak of the recovery,” said David Wyss, an economist at DRI-McGraw Hill, a Lexington, Mass., economic forecasting firm.

“In 1992, when rates were high, it was because of structural problems in the economy, including a large federal deficit. Rates were too high then and they were retarding the recovery, but now we are seeing a rise in rates because of the upswing in the business cycle.”

“We are seeing the fruits of the President’s plan,” said Rob Shapiro, an economist with the Progressive Policy Institute and a former Clinton campaign adviser.

After promoting the economic package last year on the promise of lower interest rates, Administration officials are especially concerned about getting the message out to voters that this year’s rate increases do not mean that the Clinton deficit-reduction plan was a failure.

But they realize that higher rates are bad political medicine, especially right before an election in which the Republicans have a shot at taking control of one or both houses of Congress.

“You can never look at just one piece of the economic landscape, you have to look at the whole picture to understand what’s going on with interest rates,” said Gene Sperling, a White House economic adviser.

“When we came into office, interest rates were high because of a public perception that the public sector--the government--was growing too fast (and) the deficit was not under control,” Sperling added. “Now, interest rates are higher because you have a growing economy and a perception that the demand for capital from the private sector is rising. Those are two very different scenarios for the American economy.”

Of course, Republican politicians and allied economists are not willing to give Clinton credit for the drop in rates. They see this fall’s rapid increase in rates as proof that Clinton’s plan had nothing to do with the recovery.

Further, they now charge that most of the credit for faster growth should instead go to Fed Chairman Alan Greenspan, who they believe kept interest rates down late last year to help Clinton.

“President Clinton is the herald of happy talk about the economy, but the facts of life are catching up with him,” said Rep. Dick Armey (R-Tex.), chairman of the House Republican Conference.

“The President sustained the recovery that began in March, 1991--long before he came into office--primarily because interest rates were purposefully held down by the Federal Reserve,” Armey said. “We know now from Bob Woodward’s book ‘The Agenda’ that rates were held down on purpose by the Fed after Greenspan and Clinton had come to a secret understanding.”

Said William Niskanen, chairman of the Cato Institute, a conservative Washington think tank: “The Clinton Administration made a fundamental mistake in trying to sell deficit reduction as a means of reducing interest rates. Deficit reduction is valuable for other reasons but not because it leads to lower rates.”

To be sure, independent economists disagree over how much of the credit for last year’s plunge in interest rates should be given to Clinton and his economic policies. And most disagree with Robert E. Rubin, chairman of the National Economic Council at the White House, who argues that virtually all of the drop in rates came because of the Clinton plan.

Yet many still believe that as much as half of the decline in rates can be attributed to the deficit-reduction package, and they agree that rates might now be as much as half a percentage point higher than they are today if the deficit had not been reduced.

“It’s debatable how much credit he should get, but Clinton did have a deficit-reduction plan that the financial markets viewed as credible,” said Ross DeVol, an economist at the WEFA Group, an economic forecasting firm based in Bala Cynwd, Pa.

Wyss said DRI-McGraw Hill believes that, out of a cumulative decline of just over 2 percentage points in long-term rates between early 1992 and the fall of 1993, the Clinton plan can be credited with about 0.75 to 1 percentage point of the decline.

DeVol said he believes that if the federal deficit were still above the $300-billion annual level, long-term rates would be as much as half a percentage point higher than they are today.

When the Administration came into office, the deficit for fiscal 1994 was forecast to hit $305 billion; the White House announced this week that the 1994 deficit had fallen to $203 billion, thanks both to rapid economic growth and to the Clinton deficit-reduction plan.

Of course, bond market analysts and other economists stress that the Fed has played a more critical role in determining the direction of interest rates than has the Administration’s budget policy.

“Deficits are cyclical beasts. They will rise and fall with the business cycle and the economy. And so deficits only affect rates and the bond market at the margins,” said Joe Lavorgna, a credit market analyst at UBS Securities in New York. “By far the biggest factor right now is the Fed.”

Still, Rubin argued, that proves his point. The Clinton economic policies have liberated the financial markets from their previous fixation on federal deficits, he said.

Now, interest rates in the credit markets are free to rise and fall based on economic fundamentals. The Fed has raised rates this year because the economy is better, he added.

“The basic question when Clinton took office was, how do you get the economy moving again?” Rubin said. “You couldn’t use deficit financing because the deficit was already huge. And so that took away a traditional tool. Instead, we saw that if we could reduce the deficit and if we could convince the markets that it was a credible plan, we could bring down interest rates and generate a recovery that way. And that has happened.

“I think we have dramatically reduced expectations about the deficit; we have reduced the deficit premium that used to dominate the thinking in the financial markets,” Rubin said.