- The Washington Times - Tuesday, October 11, 2005

When the Federal Reserve’s monetary-policy committee last month lifted the federal-funds rate a quarter-percentage point for the eleventh time since June 2004, it raised its benchmark short-term interest rate to 3.75 percent. Explaining its latest action, the Fed declared that “monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity.”

In Fedspeak, “monetary policy accommodation” simply means that the Fed continues to believe that its actions remain expansionary. The first variation of such accomodation appeared on Jan. 30, 2002. Then, the fed-funds rate stood at 1.75 percent, which was 4.75 percentage points below its cyclical peak of 6.5 percent that prevailed 13 months earlier. It was not known at the January 2002 meeting that the official arbiter of the business cycle would later determine that the recession had ended the previous November.

It is, however, interesting to note that, four years into the economic expansion, the Fed acknowledges that it finds it necessary to continue pursuing a monetary policy that remains “accommodative.” This becomes all the more interesting when one realizes that fiscal policy has been very expansionary over the past three years, with budget deficits averaging about $370 billion annually.

After the budget deficit declined in fiscal year 2005 from its two successive nominal records, some private forecasters are projecting that the Katrina-influenced 2006 budget deficit could easily pierce the $400 billion level. Based on several forecasts of Fed action over the next year and the projections from the futures markets — which expect the federal-funds rate to be 4.5 percent at the middle of next year — the consensus appears to be that the Fed’s monetary policy will remain “accommodative” through the fifth year of an expansion.

How aggressively “accommodative” is Fed policy today? The real (i.e., inflation-adjusted) fed-funds rate is a mere 0.15 percent, and once the September consumer-price data are released Friday, the real fed-funds rate will likely revert to negative territory.

Regarding fiscal policy, the Fed minutes from its Sept. 20 meeting pessimistically observe: “The substantial step-up in government spending would add to federal deficits that were already large and underscored the worrisome loss of fiscal discipline in recent years.”

Believing that the new 3.75 percent federal-funds rate “would likely be below the level that would be necessary to contain inflationary pressures,” the Fed understandably concluded that “further rate increases would probably be required.”

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