- The Washington Times - Monday, August 9, 2004

Federal Reserve Chairman Alan Greenspan and his colleagues on the Fed’s monetary policy-making committee meet today to decide whether to raise their principal target interest rate, the federal funds rate. That’s the rate banks charge each other for overnight loans of excess reserves on deposit at the Fed.

When the policy-making committee last met at the end of June, it did so amid signs that the belated acceleration of the post-2001 economic expansion had all the appearances of being self-sustaining. Meanwhile, inflationary pressures had begun to intensify. In late June, the latest payroll employment data revealed that nearly 1 million jobs had been created during the previous three months. After having slashed the federal funds rate from 6.5 percent in early 2001 to 1 percent in June 2003, the Fed increased its target rate on June 30 for the first time since mid-2000, raising it one-quarter of a percentage point to 1.25 percent. June’s policy action was designed to be the first of a series of incremental increases in short-term interest rates. In a carefully orchestrated, meticulously telegraphed maneuver for which the Fed had spent months preparing the financial markets, those increases were to be implemented at a pace that was — in Fedspeak — “likely to be measured.”

Since the Fed’s last meeting, the economy has hit what Mr. Greenspan has aptly called a “soft patch.” June retail sales declined, as did June’s index of leading economic indicators. The initial estimate of the inflation-adjusted annualized growth rate of gross domestic product for the second quarter came in at 3 percent, well below expectations. Figures for nonfarm payroll employment in June and July averaged an even more modest 55,000 increase per month.

Meanwhile, largely due to rapidly rising energy prices, inflation has accelerated. The consumer price index (CPI), which increased 1.9 percent during 2003, has risen at a 4.9 percent annual rate during the first six months of 2004. Even the core CPI, which excludes the volatile energy and food sectors, has increased from 1.1 percent during 2003 to an annual rate of 2.6 percent for the first half of 2004.

In the face of rapidly rising world oil prices, and at least for the time being, the Fed will likely continue to follow its game plan of “measured” increases in short-term interest rates. Thus, the Fed will probably raise the federal funds rate by another quarter point today to 1.50 percent.

In the current circumstances, one very important point needs to be emphasized: As long as the rate of inflation rises faster than the Fed increases short-term rates, the real (i.e., inflation-adjusted) short-term interest rate will actually fall. This dual trend will likely persist throughout 2004. That means that monetary policy will remain extremely accommodative for the foreseeable future.

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