- The Washington Times - Tuesday, January 11, 2005

When the minutes of the Federal Open Market Committee’s (FOMC) December meeting were released Jan. 4, they were instantly branded as hawkish. Stock prices plunged and Treasury yields rose in a not atypical over-reaction.

Why? Because some FOMC participants expressed concern about the growing inflation risk. But is that so surprising? The data tell us economic expansion continues, closing the gap between actual and potential output, which means tighter markets and increasing inflation pressure. That’s usually what happens when the economy moves up the business cycle. It’s as if Wall Street didn’t believe what the data were saying until FOMC members first acknowledged it.

The FOMC broke new ground this time by releasing its minutes earlier than usual — three weeks after its last meeting rather than waiting until after its next meeting.

This break with past practice continues the Fed’s long-term policy to become more transparent to the public. The shorter release schedule will continue and is important in providing markets with timelier information on committee assessment of economic conditions and its policy inclinations. Better information means more efficient and more stable markets.

The wording of the minutes indicates the so-called hawks invoking the inflation specter were a minority. And, as is traditional, those in the minority fell into line to present a common front, supporting the majority view of a tame outlook for inflation. Thus, the committee voted unanimously to nudge up the federal funds target rate a modest quarter-point to 2.25 percent, the fifth such increase since last June.

Though the minority position didn’t prevail, the pointed division among the participants raised the probability of further interest rate increases at coming committee meetings, the next in early February. Some Fed watchers were left wondering whether the FOMC might raise the federal funds rate to as high as 4 percent or more by year-end, close to neutral territory.

Some committee members’ concerns that unnerved financial markets were wide-ranging: high oil and import prices, a weaker dollar, slowing productivity growth, minimal slack in the economy, speculation in housing markets, rising labor costs, high fiscal deficits, low national saving, and possible cost pressures from softer high-tech spending that could restrain efficiency. There was also concern that a widening yield gap between inflation-indexed and non-indexed Treasury securities might signal rising inflation expectations. Some members worried that expectations. Some members worried that low interest rates “might be contributing to excessive risk-taking in financial markets .” All in all, an imposing tableau.

Other discussants, however, presented alternative analyses, arguing inflation risks are still contained. Oil prices were expected to fall, according to the futures markets, which would reduce consumer price pressures. Economic slack, strong underlying productivity growth, and anchored inflation expectations would also help control prices.

Some participants were optimistic about deficit reduction. It was noted wages and compensation gains continue to be moderate, and businesses can absorb higher labor costs rather than pass them on by increasing prices.

Though the more optimistic view on inflation prevailed, a few FOMC members went so far as to recommend eliminating from the committee’s summary statement “forward-looking elements” about “the pace of removal of policy accommodation” (that is, such language as “measured” pace). In short, some members didn’t want to include constraining language that might limit future committee flexibility, presumably to raise the federal funds rate at more than the baby-step quarter-point pace each time in the months ahead. Although the majority did not accept this recommendation, it highlighted the split among committee members and the growing concern about inflation.

The minutes of the December meeting also included statements about the Fed staff’s economic forecast and the FOMC outlook, indicating both expected continued economic expansion above the long-term potential of about 31/2 percent annually, continuing to draw down unused resources.

The White House economic forecast this year is 31/2 percent growth, consistent with the consensus of private sector economists. Therefore, it would appear the Fed is more bullish on the economy than the administration and economists generally — a fact certainly worthy of note.

Alfred Tella is former Georgetown University research professor of economics.

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