- The Washington Times - Thursday, September 20, 2007


The legislated role of monetary policy, as dictated in the Federal Reserve Act, requires the Board of Governors and the Fed’s policy-making arm, the Federal Open Market Committee (FOMC), to seek “to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” Recent policy tensions have involved inflation and employment. Despite the fact that inflationary pressures have been worrisome lately, it is clear that Tuesday’s decision by the FOMC to lower its target interest rate by half a percentage point (to 4.75 percent) reflected the Fed’s understandable concern that an acceptable, sustainable rate of economic growth was now in jeopardy.

Problems in the housing market threaten to worsen significantly in the year ahead. While July’s median existing-home price was down only 0.6 percent compared to a year ago, there is good reason to believe that the ever-rising inventory of unsold homes on the market will eventually force a double-digit correction in housing prices. Moreover, consumption spending, which had grown by more than 3 percent in each of the three previous years, slipped below an annualized rate of 1.5 percent during the second quarter.

Then came the employment report for August, which said that not only had payroll employment actually declined, but that the relatively modest payroll gains for June and July were revised downward by nearly 40 percent. Compared to an average of more than 200,000 jobs created each month over the 2005-06 period, a mere 44,000 jobs per month were added on average during the latest three months.

On the heels of lousy second-quarter consumption growth and after August broke the streak of nearly four years of uninterrupted nonfarm payroll-employment growth, it is hard to argue with the decision this week to lower the target interest rate for the first time in more than four years.

Meanwhile, before the Fed announced its decision, it received encouraging news on the inflation front. The Labor Department reported Tuesday that producer prices for finished goods declined 1.4 percent in August. That welcome development followed a worrisome period during which wholesale prices had jumped skyward during five of the preceding six months. The day after the Fed acted there was more good news on inflation. Consumer prices declined 0.1 percent in August, reducing the compound annual rate of consumer-price inflation for the latest three months to 0.7 percent and the rate over the last 12 months to 2 percent. On the other hand, oil prices in recent days have hurdled the $80 level. While it is worth noting that this level still falls significantly below the inflation-adjusted oil-price level of more than $100 per barrel reached during the early 1980s, oil above $80 nonetheless confirms that inflationary pressures remain strong. All in all, the Fed made the right call.

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