- The Washington Times - Tuesday, June 25, 2002

Amid cascading stock markets and a lackluster recovery, the Federal Reserve's policymaking committee meets today and tomorrow to discuss the condition of the U.S. economy and to determine whether changes in short-term interest rates are in order. Once the Fed peruses the economy, it's highly unlikely that it will act on the interest-rate front. Nor should it.
Despite the fact that the economy expanded by a seemingly robust 5.6 percent annual rate in the first quarter and the unemployment rate declined from 6 percent in April to 5.8 percent in May, now is hardly the time to reverse the Fed's accommodating monetary policy. Last year, that much-needed aggressive policy chopped 4.75 percentage points off the pivotal overnight federal-funds interest rate, which stood at 6.5 percent in January 2001. Since the Fed trimmed that rate for the 11th time in 12 months in December, the Fed funds rate has remained at 1.75 percent, its lowest level in four decades, and is likely to remain at that historic low at least through the summer.
While there are signs that the economy may have emerged earlier this year from the recession that began in March 2001, economic growth during the first quarter was not nearly as impressive as the 5.6 percent annual rate suggests. Because 3.5 percentage points of that growth rate resulted from inventory changes, real final sales increased by only about 2 percent for the first three months. In addition, the rate of growth for consumer spending, which increased by 6.1 percent during the fourth quarter (when real final sales advanced at a 3.8 percent annual rate), sharply decelerated during the first quarter to an annual rate of 3.2 percent. More recently, retail sales for May actually declined by nearly 1 percent. As households see their wealth in the form of stocks continue to plunge, their inclination to spend to say nothing of their ability to spend, insofar as their extremely low savings rate is concerned may well be negatively impacted in the future.
Meanwhile, business investment spending, which declined by an annual rate of more than 8 percent in the first quarter, shows no sign of recovering in the near future. And while industrial production increased for the fifth consecutive month in May, it did so at the slowest pace (0.2 percent) this year. Unused capacity remains at nearly 25 percent, indicating that sustainable increases in demand will have to be substantial before investment spending is likely to reverse its downward direction. Additional corporate profits the real kind, not the sort that result from accounting illusions would also help.
Fortunately, inflation appears nowhere on the horizon. Consumer prices have increased a minuscule 1.2 percent over the past 12 months. During the same period, producer prices for finished goods have actually declined 2.7 percent. In fact, in many sectors, deflationary pressures are a greater concern than inflationary pressures. Thus, for the time being, monetary policy needs to remain accommodating.

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