- The Washington Times - Tuesday, September 20, 2005

The Federal Reserve, in an unusual non-unanimous decision criticized as “insensitive,” yesterday voted to raise interest rates despite the economic disruptions caused by Hurricane Katrina.

The Fed said it does not expect the immediate rise in joblessness and decline in growth from the storm to pose a “persistent threat” to the economy, and that it must address the possibility that the soaring energy prices triggered by Katrina will fan inflation.

Mark Olsen, a Fed governor, dissented in the 9-1 vote, saying he thought a pause in the Fed’s string of quarter-point rate increases since June 2004 was warranted. Many agreed on Wall Street, where stocks and bonds tumbled in response to the Fed’s move.

Lawmakers on Capitol Hill and some economists said the central bank was being “insensitive” by increasing the cost of rebuilding from the storm by raising the interest rates on construction loans, while adding to the burden on consumers already hard-pressed by skyrocketing gasoline prices.

The Fed acknowledged the extraordinarily broad devastation from the hurricane, which killed almost 1,000 people and put nearly 1 million out of their homes and work — some temporarily, some indefinitely.

It also acknowledged that the disaster, which caused consumer confidence to plunge to a 13-year low earlier this month, has “increased uncertainty” about the economy’s performance.

But the central bank noted that the economy was growing solidly “before the tragic toll” and should be able to withstand the shock.

Even with the nearly three percentage point boost in interest rates since the Fed started its campaign, it said the level of rates remains low by historical standards and is still stimulating the economy.

The board raised the federal funds rate, which is the rate it targets on overnight loans among banks, to 3.75 percent. Commercial banks raised their prime lending rates by a corresponding amount, to 6.75 percent.

Richard Yamarone, an economist with Argus Research Corp., said the Fed ignored “a chorus of congressional leaders, business figures and investors” because it fears the sharp rise in energy prices this year will push the inflation rate over the psychological threshold of 4 percent.

Although many economists — and even the Fed — note that inflation excluding volatile energy prices remains tame at about 2 percent, persistently higher energy costs nevertheless will stoke inflation by prompting higher cost-of-living increases and a push for higher wages, he said.

Katrina fueled inflation not only by shutting down 5 percent of U.S. energy production and driving up energy prices, but also by boosting the costs of transportation and building materials, Mr. Yamarone noted.

“A Fed pause, or even a rate cut, would have done nothing to help the Gulf Coast area,” he said. “It is more important to address the drag of inflation than to pause out of compassion for a region that was closed to business for a week.”

But Sen. Jim Bunning, Kentucky Republican, said Fed Chairman Alan Greenspan was “insensitive” and out of touch with the plight of working families.

“Maybe if he didn’t have a government car and driver and had to pay for his own gas like ordinary folks, or if he lost everything he owned in a hurricane, he would be a bit more compassionate,” the senator said.

Peter Morici, a business professor at the University of Maryland, said the Fed and many economists consistently have underestimated the severity of the storm and its effect on the economy, initially dismissing it as little worse than previous storms.

The central bank may be making a mistake like it did in 1990, when Mr. Greenspan led a campaign to raise rates in the face of a weakening economy, he said. Many economists blame the Fed’s unresponsiveness for precipitating the 1990-91 recession.

“Falling retail sales and consumer confidence indicate the mood of the country is turning sour,” and the Fed’s move yesterday contributes to the pessimism, Mr. Morici said.

“By raising interest rates in an economy already slowing and buffeted by Hurricane Katrina, Mr. Greenspan needlessly risks driving the economy into recession, something he did accomplish for the first President Bush,” he said.

Richard Berner, an economist with Morgan Stanley, said the Fed’s task is particularly challenging now because of the explosion in energy costs, inflation and federal spending — which also is inflationary — prompted by Katrina.

Although the decision to raise rates may be a good one aimed at quelling an inflation threat, communicating that strategy is difficult in light of the public outcry over federal unresponsiveness to the storm.

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