- The Washington Times - Tuesday, November 9, 2004

In the wake of several recent positive economic reports, including Friday’s blockbuster employment report revealing that the economy created nearly 350,000 jobs last month, the Federal Reserve today will almost certainly continue its policy of gradually raising short-term interest rates. The Fed is expected to increase the federal funds rate, which is the interest rate banks charge each other for overnight loans, by another quarter-percentage point. At this stage of the economic recovery, that is the right move.

After reducing the fed-funds rate from 6.5 percent in early 2001 to a 45-year low of 1 percent in June 2003, the Fed began raising that target rate four months ago. At each of its past three meetings, the Fed’s policy committee has increased the federal funds rate by a quarter of a percentage point. Today’s likely increase would raise this rate to 2 percent.

During 2001 alone, the Fed reduced the overnight rate 11 times, cumulatively lowering it by 4.75 points from 6.5 percent in January to 1.75 percent by year’s end. Officially, the 2001 recession began in March and ended in November. But a lackluster recovery ensued, attributed in part to the economic jolt administered by the September 11 terrorist attacks, the burgeoning corporate-governance scandal that erupted with Enron’s December 2001 bankruptcy and the general shallowness of the 2001 recession itself. Then, as the specter of deflation began to threaten the slowly recovering economy, the Fed took out an anti-deflation insurance policy in November 2002 by lowering short-term rates another half point. Fed Chairman Alan Greenspan and his colleagues paid what amounted to yet another anti-deflation insurance premium in June 2003 by reducing the overnight rate another quarter point to 1 percent.

Ultimately, the deflationary threat was thwarted, but to achieve its victory, the Fed maintained its target rate at 1 percent for a year. The rate has now been 2 percent or less for three years. Earlier this year, the Fed rightly concluded that it was time to gradually reverse monetary accommodation as the recovery finally began to accelerate and key inflation indexes began to increase.

Specifically, over the past six quarters, the annual rate of economic growth has exceeded 4.5 percent, with both consumption and business investment spending now growing at impressive rates. Meanwhile, through September, the year-to-date annual rate of consumer price inflation has risen to 3.5 percent compared to 1.9 percent for the same period in 2003, while the annual rate of core consumer prices, which exclude the energy and food sectors, has risen from 1.1 percent last year to 2.3 percent this year.

At this point in 2004, with key inflation rates having increased faster than the Fed’s target interest rate, an additional upward adjustment in the overnight rate today is both appropriate and necessary.

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