Subject: (BN ) Fed's Most Important Step Wasn't Rate Increase: John
From: JOHN BERRY, BLOOMBERG/ WASHINGTO (JBERRY5@bloomberg.net)
Date: Wed Dec 15 2004 - 09:16:02 EST
Marty Feldstein suggested that as a participant in the NBER monetary policy
group that you might be interested in seeing the columns I am writing, most of
which involve the Fed in one way or another. I hope you will find them of
interest. Any comments would be welcome. John Berry
Fed's Most Important Step Wasn't Rate Increase: John M. Berry
2004-12-15 00:01 (New York)
(Commentary. John M. Berry is a Bloomberg News columnist.
The opinions expressed are his own.)
By John M. Berry
Dec. 15 (Bloomberg) -- The most important step Federal
Reserve officials took yesterday was not raising their target for
the overnight lending rate by a quarter point. It was the
decision to release the minutes of each Federal Open Market
Committee session three weeks after it occurs instead of waiting
until a day or two after the next meeting.
Earlier release of minutes will give financial markets more
timely information about Fed thinking before the subsequent
policymaking session. Thus, when the minutes of yesterday's
meeting are published on Jan. 4, the world will have much more
knowledge about what went on in the Fed boardroom than could
possibly been conveyed in the FOMC's brief statement issued after
the meeting.
More than a decade ago, Fed Chairman Alan Greenspan and his
colleagues decided it would make the conduct of monetary policy
easier if they shared more information about their decision with
the public. In other words, to become more transparent.
Since then, many steps have been taken in that direction.
Not all of them have been successful, and as Fed Vice Chairman
Roger W. Ferguson Jr. has said on more than one occasion, the
process is ``a work in progress.''
Increased Transparency
Nevertheless, the increased transparency is a key reason the
Fed has unprecedented credibility as it pursues its goal of price
stability. That credibility, in turn, has given the central bank
the luxury of being able to wait for economic developments to
unfold before taking actions that might have turned out to be
premature.
Actually, that's the case today. After holding the overnight
rate target at 1 percent for a year to ward off a possible
episode of deflation, the Fed began raising it at the end of June
at a ``measured'' pace, which so far has proved to be a quarter-
point per meeting.
Over the past six months, prices of oil and numerous other
commodities soared with only a small adverse impact on inflation
expectations regarding the next two or three years. As the
Federal Open Market Committee statement put it, ``Inflation and
longer-term inflation expectations remain well contained.''
Fed's Credibility
Perhaps the best example of that is that yields on 10-year
U.S. Treasury notes yesterday stood at 4.12 percent, almost a
half-percentage point lower than when the Fed first raised the
overnight rate target on June 30. That is, the target has gone up
by 125 basis points while the 10-year yield has dropped by 50
basis points. That has got to be largely the result of Fed
credibility as an inflation fighter.
In terms of the assessment of the state of the economy and
Fed policy, the committee's statement yesterday was virtually
identical to the one released after its Nov. 10 meeting.
``The committee perceives the upside and downside risks to
the attainment of both sustainable growth and price stability for
the next few quarters to be roughly equal. With underlying
inflation expected to be relatively low, the committee believes
that policy accommodation can be removed at a pace that is likely
to be measured,'' the statement said.
What does that tell us?
What It Indicates
For one thing, it indicates that Fed officials aren't overly
concerned that some of the cost pressures on businesses from
higher energy and raw materials costs are about to be passed
through to consumers.
On the other hand, the wording also signals that the policy
makers believe that, at 2.25 percent, the overnight rate target
is still low enough that it is providing stimulus to the economy.
And it also implies that at some point that stimulus should be
removed.
What it doesn't tell us is whether the committee will raise
the target again at the next meeting. A ``measured'' pace in
removing policy accommodation incorporates, according to some Fed
officials, the possibility of letting one or more meetings go by
without a rate increase.
Clearly, incoming data will determine the decision on Feb. 2.
Some economists, such as David Rosenberg, chief North
American economist for Merrill Lynch & Co., say the Fed is done.
``We believe that today's rate hike represents the last for
at least a year as GDP growth falls to 3 percent in 2005 from
around 4.5 percent this year and core CPI trends lower to 1.7
percent from 2 percent currently,'' he told clients yesterday.
What Next?
Tom Gallagher of International Strategy & Investment said in
an interview that he expects only one more quarter-point addition
to the target, either at the February or March FOMC meeting.
Economist James Glassman of JPMorgan Chase Securities, who
predicts inflation will ``remain in the zone of price stability''
next year, said in an interview that he ``would not be shocked if
the Fed got to the 3 percent to 4 percent range and stopped.''
Yet other analysts are predicting the Fed will raise rates
at every meeting in 2005, a pace that would put the target at
4.25 percent a year from now.
That wide variation is primarily the result of different
growth and inflation forecasts -- and the Fed is keeping its
options open as things unfold.
A key issue for the Fed will be its estimate of how much
slack there is in the U.S. economy. That's a difficult call,
though officials generally are convinced there is some.
Industrial Production
The Fed's report on last month's industrial production
released yesterday pegged the capacity utilization rate at 77.6
percent, up only from the cyclical trough of 74 percent in
October 2003. A more normal rate would be in the low 80s, so
that's a sign there is plenty of unused capacity at the moment.
Meanwhile, the unemployment rate is 5.4 percent, down half a
point over the past 12 months as a result of economic growth of
about 4.5 percent. The consensus growth forecast for next year,
according to a Bloomberg survey of 62 economists, is 3.6 percent,
about in line with how fast many Fed officials believe the
economy can expand without reducing joblessness.
That estimate of potential growth got some backing this week
when the New York Federal Reserve Bank released a new study of
productivity growth.
Unemployment and Inflation
``We project labor productivity growth of 2.6 percent per
year for the next decade, a significant increase from our earlier
projection of 2.2 percent,'' wrote economists Dale W. Jorgenson
of Harvard University, Mun S. Ho, a visiting scholar at Resources
for the Future in Washington, and Kevin J. Stiroh of the New York
Fed.
``There is considerable uncertainty in these projections,''
they wrote. ``Nonetheless, there is little evidence to suggest
that the technology-led productivity resurgence is over or that
the U.S. economy will revert to the slower pace of productivity
growth observed in the 1970s and 1980s.''
A 2.6 percent annual increase in productivity coupled with
about a 1 percent increase in the workforce indicates growth of
potential output of about 3.6 percent.
In other words, if the consensus forecast is correct,
unemployment may fall very little in 2005, keeping inflation
pressures from rising and likely limiting Fed rate increases.
--Editors: Ahearn, Todd
Story illustration: To compare the two most recent statements,
see {NXTW NSN I8Q8ZA3PWT1D <GO>}.
To compare the Fed's target rate with the monthly
unemployment rate: {FDTR <Index> USURTOT <Index> HS 2 <GO>}.
To read other Berry columns, {NI BERRY <GO>}. To comment on this
column, click on {LETT <GO>} and send a letter to the editor.
To contact the writer of this column:
John M. Berry in Washington at (1)(202) 624-1962 or
jberry5@bloomberg.net.
To contact the editor responsible for this column:
Bill Ahearn at (1)(212) 893-4197 or
bahearn@bloomberg.net.
[TAGINFO]
NI FED
NI GOV
NI ECO
NI US
NI TRE
NI TOP
NI COLUMNISTS
NI COLUMNS
NI BERRY
NI CEN
NI FRX
NI FX
NI FEA
NI INF
#<698734.251583>#
-0- Dec/15/2004 5:01 GMT
