- The Washington Times - Monday, December 13, 2004

In the wake of a precipitous fall in the value of the dollar, the Federal Reserve’s monetary-policy committee convenes today amid the widely held expectation that the central bank will continue to raise its target interest rate by 25 basis points, or one-quarter of a percentage point. Lifting the federal funds rate, which is the interest rate banks charge each other for overnight loans, from 2 percent to 2.25 percent is the right decision.

It will be the fifth quarter-point increase that the Fed has enacted since June. Before then, Fed Chairman Alan Greenspan and his colleagues had spent months preparing the markets for a “measured” pace of tightening following an extraordinary period of monetary stimulus. Indeed, as Mr. Greenspan mischievously remarked in Germany recently, “Rising interest rates have been advertised so long and in so many places that anyone who hasn’t appropriately hedged his position by now obviously is desirous of losing money.”

This small increase in the overnight rate, which will be nearly instantaneously reflected in other short-term interest rates, would remove a modicum of economic stimulus from an economy that has been operating on stimulative steroids for three years now. In the monetary arena, for example, since November 2001, when the 2001 eight-month recession officially ended, the federal funds rate has been 2 percent or less. That includes a 21-month period, from November 2002 through July 2004, when the overnight rate never exceeded 1.25 percent.

On the fiscal front, the federal budget moved from a $236 billion surplus in fiscal 2000 to a $413 billion deficit in fiscal 2004. That trend amounts to a massive shift of $650 billion per year over a mere four years.

Meanwhile, the dollar has been falling for nearly three years now. Three years ago, for example, a euro cost 90 cents. Today, a euro, which is approaching $1.35, costs nearly 50 percent more. Other things being equal, a decline in the value of a nation’s currency stimulates its economy by making its exports relatively cheaper and by shifting consumption from higher-priced imported goods to those produced domestically. However, notwithstanding the stimulative effect of a declining dollar, that process has not occurred, as the nation’s trade deficit by yearend will have ballooned from less than $400 billion in 2001 to about $600 billion this year. While other factors have clearly offset the dollar’s decline, it is nevertheless probably true that the nation’s dreadful trade balance would be even worse in the absence of a deteriorating currency. Following today’s likely increase, monetary policy will remain extremely stimulative.

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