- The Washington Times - Monday, September 18, 2006

After raising its short-term target interest rate by a quarter point at each of 17 consecutive meetings beginning in late June 2004, the policy-making body of the Federal Reserve paused at its Aug. 8 meeting, keeping the federal-funds rate at 5.25 percent. Analysts are nearly unanimous in their projections that the Fed will once again refrain from lifting short-term rates at its policy meeting on Wednesday. While we believe that the Fed paused too early, we readily acknowledge that the case for further tightening was not as open-and-shut in August as it had been for the 17 previous decisions.

Since the Fed policy-makers last convened six weeks ago, the Labor Department has issued two monthly reports on consumer prices. The closely watched core consumer price index, which excludes the volatile food and energy sectors, increased by 0.2 percent for both July and August. That monthly rate corresponds to an annualized rate of 2.4 percent, which exceeds Fed Chairman Ben Bernanke’s “comfort zone” of 1 percent to 2 percent for core price inflation. On the other hand, core consumer prices had increased by 0.3 percent in each of the four preceding months, generating a wholly unacceptable annualized rate greater than 3.5 percent. While the rise in core prices has moderated, the trend still remains too high.

Another major development on the pricing front since the Fed last met involves crude oil, whose next-month price reached $77.03 per barrel in mid-July and closed at an equally frightening $76.98 the day before the Fed announced its pause in August. In the face of oil’s soaring price, the Fed decision amounted to a big gamble. So far, that gamble seems to be paying off. The next-month price for oil fell below $64 last week. Balancing the welcome development in the oil-futures market were the worrisome revisions to unit labor costs reported by Labor Department earlier this month. After rising by 0.3 percent (2003), 0.7 percent (2004) and 2 percent (2005), unit labor costs in the nonfarm business sector jumped at an average annual rate of 7 percent during the first half of 2006.

Should subsequent developments, such as an intensification of inflationary pressures, prove that the Fed erred, the central bank can recover lost ground by resorting to its widely followed practice in earlier times. Indeed, during its 12-month tightening cycle that began in February 1994 and produced in a cumulative 3-percentage-point increase, the Fed three times raised its target rate by a half-percentage point and once by three-quarters of a point. The end result was the fabled “soft landing” that central bankers always dream about but rarely achieve.

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