- The Washington Times - Monday, May 5, 2003

It has been six months since the Federal Reserve’s monetary policy-making committee last reduced the overnight interest rate. At its Nov. 6 meeting, the Fed chopped a half-percentage point off the federal funds rate, reducing it to 1.25 percent, its lowest level in 42 years. At its meeting today, the Fed ought to lower the federal funds rate again by knocking off a quarter-percentage point and reducing it to 1 percent. It would be cheap insurance against a faltering economy and intensifying disinflationary pressures that could soon lead to a dose of deflation. In its statement following the Nov. 6 meeting, the Fed noted that “greater uncertainty, in part attributable to heightened geopolitical risks, is currently inhibiting spending, production and employment.” The Fed then optimistically predicted that its “additional monetary easing should prove helpful as the economy works its way through this current soft spot.” Six months later, however, the economy, whose annual growth rate has averaged a mere 1.5 percent over the past two quarters, has become even softer. Nonfarm employment has plunged by more than 500,000 jobs during the past three months. Industrial production has declined during three of the last four reported months (and six out of the last eight). Meanwhile, unused production capacity has now risen above 25 percent. And business investment resumed its decline during the first quarter. Finally, consider consumption, which has accounted for nearly 70 percent of gross domestic product in recent years. Except for a 4.2 percent increase during last year’s third quarter, which flowed directly from the auto industry’s loss-inducing 0 percent finance incentives, the growth rate of personal consumption expenditures has ratcheted downward each quarter since the fourth quarter of 2001, falling to a modest 1.4 percent in the first quarter.As if this should not to be sufficiently worrisome to the Fed, the central bank’s favorite price index — the so-called “core PCE deflator,” which measures the inflation rate of personal consumption expenditures less food and energy — increased at a minuscule annual rate of 0.9 percent during the first quarter. That’s half the average rate of increase during the last three years, when fears of deflation mounted. In testimony last week before the House Committee on Financial Services, Fed Chairman Alan Greenspan cautioned: “Substantial further disinflation would be an unwelcome development, especially to the extent it put pressure on profit margins and impeded the revival of business spending.” As a simple matter of arithmetic, with disinflationary pressures now below 1 percent, additional downward movement need not be large to be substantial — and potentially catastrophic.As it happens, the monetary antidote for the increasingly soft economy and the intensifying disinflationary pressures is the same: lower short-term interest rates.



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