Subject: 1(BN ) Fed Will Increase Rates Next Month and Afterward: Jo
From: JOHN BERRY, BLOOMBERG/ WASHINGTO (JBERRY5@bloomberg.net)
Date: Wed Jan 26 2005 - 09:00:57 EST
Fed Will Increase Rates Next Month and Afterward: John M. Berry
2005-01-26 00:19 (New York)
(Commentary. John M. Berry is a Bloomberg News columnist.
The opinions expressed are his own.)
By John M. Berry
Jan. 26 (Bloomberg) -- Federal Reserve officials, quite
pleased with the state of the U.S. economy and the path of
monetary policy, will raise their target for the overnight
lending rate by another quarter point at their policy-making
session next week.
That will be six meetings in a row at which the Federal Open
Market Committee has taken that same step, and if the economy
performs as officials expect, policy will continue on the same
path for some time to come.
On the other hand, with each quarter point increase, the
hurdle to raising the rate at the subsequent meeting becomes
greater. Officials say they don't know what federal funds rate
would be consistent with keeping inflation stable in an economy
operating at its potential, only that they hope to know it when
they get there.
When they started raising the target last June, it was at
only 1 percent, well below anyone's notion of a ``neutral'' rate.
With next week's action, it will be at 2.5 percent, still
undoubtedly not a ``neutral'' rate, though much closer.
In many ways, this is an unprecedented policy path for the
Fed because it is the first time in nearly half a century that
the central bank has confronted an economic recovery and
expansion in which inflation was already at a desired level. So
the policy goal is not to bring inflation down, rather to keep it
from accelerating significantly.
Countering Some Analysts
The key to the policy decision at each meeting will be the
incoming economic data, the anecdotes about business activity the
Fed's widely cast information gathering network picks up and any
changes in the economic outlook. As of now, those all appear to
point toward growth of about 3.5 percent this year, or perhaps a
bit more, with inflation remaining tame.
None of this is a secret. Numerous Fed officials have laid
out their intentions in recent speeches and interviews, and for
the first time, analysts have available the minutes of the last
committee meeting on Dec. 14.
Some Fed officials, such as Janet L. Yellen, president of
the San Francisco Federal Reserve Bank, have even gone out of
their way to counter the conclusion of some analysts that the
discussion at that meeting about the prospects for inflation may
have signaled a rising concern that could lead to a more
aggressive drive to raise interest rates. A few analysts
suggested the minutes' language pointed to a 50-basis point
increase at next week's meeting.
Yellen on Inflation
In a speech in San Francisco last week, Yellen said
otherwise. While she included the standard disclaimer that she
was speaking only for herself, not her colleagues, her words
might have been spoken by many of them.
``When the minutes were released on Jan. 4, there was a lot
of focus on the paragraphs that described some risks that could
lead to higher inflation,'' Yellen said. ``But if you read
through the document, you'll find that it also contains a
discussion of factors that may put downward pressure on
inflation. Indeed, at several points, the minutes say that the
committee felt that inflation and longer-term inflation
expectations remain well contained and the risks to price
stability are roughly equal. In fact, those are the very words
the committee members agreed to use in the official press
statement.''
`Equal Time'
Since the public reaction to the minutes focused on some
forces that could cause inflation to rise, she said, ``I thought
I'd use this occasion as a chance to give `equal time' to the
other side -- the counterbalancing forces that can hold inflation
in check.''
She then proceeded to do so, putting those forces in the
context of an economy growing at a healthy pace, though less than
one might have expected given the amount fiscal and monetary
stimulus it had received. Based on the December minutes and
public statements by other officials, her analysis is generally
shared by a majority of her colleagues, though not necessarily
all of them.
With the unemployment rate just under 5.5 percent, there is
enough slack in labor markets that it should reduce inflationary,
Yellen said. The amount of slack, and how fast it may be absorbed
by employment growth, isn't clear because of the decline in labor
force participation during the 2001 recession. If that drop is
cyclical, it should be reversed as the economy grows with slack
in labor markets continuing.
``If it's not -- that is, if participation does not rise or
continues to fall -- this will mean the remaining slack in the
economy will diminish faster, creating upward pressure on
inflation sooner,'' she said.
Long-term Inflation
Yellen's second point was that long-term inflation
expectations -- those for inflation five to 10 years out --
appeared not to have increased as economic growth improved. Thus,
neither workers nor employers seem likely to seek or grant higher
wage and salary increases because of higher inflation
expectations. And there is no evidence of that in recent changes
in compensation, she said.
Even if the rate of change in labor compensation were to
increase, inflation might nevertheless fall because ``the extent
to which businesses have marked up the prices of their products
over the unit labor costs they face has been extraordinarily
large for some time now,'' she said. Those markups could decline,
offsetting compensation gains or result in lower inflation.
Yellen acknowledged that higher oil prices and the decline
in the dollar could add to inflationary pressures. ``The key
question is whether this upward pressure on inflation will
persist,'' she said. Even if the pressure were to persist, the
real issue would be whether that affects long-term inflation
expectations, something that has not happened so far.
Productivity Growth
Her final point was whether productivity growth, which has
slowed in recent quarters from an extraordinarily high pace for
several years, will continue at its estimated trend of about 2.5
percent a year. ``If so,'' she said, ``core inflation seems
likely to remain stable, near its current moderate pace, assuming
no new developments in compensation or profit margins. I see the
risks in this regard as fairly well balanced.''
Yellen concluded by saying that monetary policy is still
accommodative and ``as the expansion firms up, that degree of
accommodation will have to diminish.'' That is, more rate
increases are in store.
If economic growth speeded up, or other risks to inflation
materialize, ``it may be appropriate to remove accommodation more
rapidly. If the expansion slows, or if we experience some of the
downside inflation risks, there will be more opportunities for
the committee to pause,'' she said.
It is hard to be more transparent than that.
--Editors: Ahearn, Wolfson
Story illustration: To compare the Fed's target rate with the
monthly unemployment rate:
{FDTR <Index> USURTOT <Index> HS 2 <GO>}. To see a series of fed
funds futures contracts: {FFA <Cmdty> CT <GO>}. For stories about
Federal Reserve actions: {FEDU <GO>}. For multimedia recordings
of Fed officials' speeches: {NCMT 93 FED <GO>}.
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.
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