- The Washington Times - Monday, October 31, 2005

The Federal Reserve’s monetary-policy committee meets today as the economy celebrates the fourth anniversary of its expansion, which began in November 2001. The Commerce Department reported Friday that annualized third-quarter growth was a robust 3.8 percent.

Appropriately, the Fed will almost certainly continue pursuing its “measured” pace for removing monetary stimulus from the robustly expanding economy en route to a “neutral” position, where monetary policy is neither restrictive nor expansionary. Increasing the interest rate that banks charge each other for overnight loans by another quarter point would raise the Fed’s target rate to 4 percent. The fed-funds rate would then be 3 percentage points above the historically low level of 1 percent, which the Fed maintained for a full year until June 2004, when it began raising its benchmark rate in quarter-point increments.

After today, the Fed’s policy committee has two more regularly scheduled meetings before Fed Chairman Alan Greenspan is expected to retire at the end of January. Mr. Greenspan has cagily declined to state the fed-funds rate that would represent neutrality in the current cycle. However, it is widely believed that he would like the Fed to finish its latest round of monetary tightening before he hands the chairman’s reins to former Fed governor Ben Bernanke, whom President Bush nominated last week.

Two additional quarter-point increases suggest a possible neutral-rate target of 4.5 percent. However, recent developments on the inflation front, including a disturbing rise in inflation expectations, indicate neutrality may be higher. September’s consumer price index (CPI) revealed that overall consumer prices had increased 4.7 percent during the past 12 months, while the core CPI, which excludes the volatile energy and food sectors, had risen 2 percent over the same period. Mr. Bernanke has identified a core rate of 2 percent as the upper limit of his comfort zone.

In the next several months, at least some of the recently soaring energy costs will likely be passed through into the core index, lifting it above Mr. Bernanke’s comfort level. To dampen dangerously rising inflation expectations, while simultaneously establishing his bona fides as an inflation hawk, Mr. Bernanke may seek to lead the Fed above 4.5 percent.

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