- The Washington Times - Monday, March 21, 2005

Now that the Republican-controlled Senate has signaled it doesn’t have the courage to exert restraint against soaring education and health-care-entitlement spending, America’s relentlessly expansionary fiscal policy seems to be on automatic pilot. That ensures that the budget deficit, which averaged nearly $400 billion during fiscal years 2003 and 2004, will remain for the foreseeable future. With little counter-cyclical help likely on the fiscal front, the Federal Reserve’s monetary-policy committee, which convenes today, should give strong consideration to accelerating its pre-emptive efforts to stifle inflationary pressures before they can manifest themselves, after which the required remedy is always stronger.

The Fed has given ample warning about its intentions. In its May 4 statement following that day’s monetary-policy meeting, the Fed gave the markets a preview of its soon-to-be-implemented interest-rate strategy. “[P]olicy accommodation can be removed at a pace that is likely to be measured,” the Fed announced. At each of the next six meetings, the Fed raised the federal-funds rate by a quarter-percentage point. The rate now stands at 2.5 percent.

Following each of those six meetings, the Fed repeated its belief that monetary policy could continue to be tightened at a “measured” pace. For nearly a year now, markets, economists and commentators have focused on that key word, while virtually ignoring the declarative sentence that has always followed “measured” each time the Fed raised its target rate. “Nonetheless,” the Fed has regularly asserted, “the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.”

With little prospect that the White House and Congress will reduce the huge full-employment budget deficits anytime soon and with annual economic growth averaging more than 4 percent during the last two years, perhaps the time has arrived for the Fed to signal the markets that its inflation-fighting intentions remain steadfast. At a minimum, the Fed should remove from its statement its intention to operate at a “measured” pace. A two-by-four approach would raise the fed-funds rate by half a point to 3 percent.

Inflationary pressures appear to be building, and not just in the energy markets. The core producer price index, which excludes the volatile energy and food sectors, has experienced its fastest 12-month increase (2.7 percent) in nearly 10 years. Unit labor costs in the nonfarm business sector have increased at an average annual rate of 2.4 percent during the last three quarters after declining during three of the preceding four quarters. Maintaining an inflation-adjusted federal-funds rate at or below zero is no longer an option.

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