June 20, 2002

The Federal Reserve Says Its Keeping Its Foot on the Gas

At the moment short-term real interest rates are negative: the 1.75% per year interest rate that the Federal Reserve has set on overnight federal funds is less than the rate at which consumer prices are rising. This is a very stimulative posture--it tells businesses that they should undertake investments that (in the short term at least) promise any profits at all, no matter how low.

Now the Federal Reserve is telling us that there are no interest rate hikes on offer for the next few months. The Federal Reserve does not have confidence that the recovery is strong and steady enough to risk disrupting it by raising interest rates and making the incentive to invest less. The Federal Reserve does not fear rising inflation enough to want to raise interest rates to put downward pressure on price increases.


| washingtonpost.com: Fed May Not Raise Rates At Least Until September | John Berry | June 20, 2002 |

The Federal Reserve now appears unlikely to raise interest rates until the fall, at the earliest, because inflation remains extremely low and the U.S. economy is not growing fast enough to create many new jobs. At the beginning of the year, some investors and financial analysts expected an initially sharp rebound from last year's recession to cause Fed officials to begin to boost their target for overnight interest rates no later than at their March 23 policymaking session. But the Fed didn't move then, or at a meeting last month, and now virtually no one expects a rate increase to come out of the session to be held next Tuesday and Wednesday.

As forecasters gradually have shaved their predictions for growth for this year, more and more analysts are saying the first rate increase won't come before September and some believe it may not come until early next year. The Fed's target for the federal funds rate, the interest rate financial institutions charge each other on overnight loans, is 1.75 percent, a 40-year low. In a speech in Los Angeles this week, Robert T. Parry, president of the San Francisco Federal Reserve Bank, rhetorically asked an audience of economists, "Where do we stand now? I think at this point we can be deliberative in approaching the issue of when [monetary] policy has to change and how aggressive it has to be."

The word "deliberative" in this context means that Parry feels the Fed can wait until the course of the economy becomes much more clear before raising rates to make sure inflation stays low -- a view shared by his colleagues...

washingtonpost.com

Fed May Not Raise Rates At Least Until September
With Inflation Low, Growth Slow, Some Say Next Year

By John M. Berry
Washington Post Staff Writer
Friday, June 21, 2002; Page E03

The Federal Reserve now appears unlikely to raise interest rates until the fall, at the earliest, because inflation remains extremely low and the U.S. economy is not growing fast enough to create many new jobs.

At the beginning of the year, some investors and financial analysts expected an initially sharp rebound from last year's recession to cause Fed officials to begin to boost their target for overnight interest rates no later than at their March 23 policymaking session. But the Fed didn't move then, or at a meeting last month, and now virtually no one expects a rate increase to come out of the session to be held next Tuesday and Wednesday.

As forecasters gradually have shaved their predictions for growth for this year, more and more analysts are saying the first rate increase won't come before September and some believe it may not come until early next year. The Fed's target for the federal funds rate, the interest rate financial institutions charge each other on overnight loans, is 1.75 percent, a 40-year low.

In a speech in Los Angeles this week, Robert T. Parry, president of the San Francisco Federal Reserve Bank, rhetorically asked an audience of economists, "Where do we stand now? I think at this point we can be deliberative in approaching the issue of when [monetary] policy has to change and how aggressive it has to be."

The word "deliberative" in this context means that Parry feels the Fed can wait until the course of the economy becomes much more clear before raising rates to make sure inflation stays low -- a view shared by his colleagues.

"Core inflation does not appear to be an imminent problem, not only because of . . . faster productivity growth, but also because there's still quite a bit of excess capacity left in the economy," he said. "In addition, there's still some uncertainty about the strength and durability of the recovery."

The minutes of the March meeting of the Federal Open Market Committee (FOMC), the central bank's top policymaking group, spelled this out: "The need to adjust monetary policy during the early stages of a recovery presented a special challenge with regard to its timing and extent in that raising rates prematurely or too precipitately could weaken or abort the recovery, while waiting too long could risk a pickup in inflationary pressures later."

Fed Chairman Alan Greenspan, Parry and other officials expect the economy to continue to expand. But according to numerous public statements, earlier this year they also anticipated that growth would slacken again after a burst of new production orders pushed growth in the first three months of the year to a very strong 5.6 percent annual rate. Those orders were needed to halt a record decline in businesses' stocks of unsold goods, and they accounted for nearly two-thirds of the first-quarter gain in the gross domestic product.

However, the swing in inventories is going to add far less to GDP in the April-June period, forecasters say. Meanwhile, consumer spending gains have diminished, and business spending on new equipment, which fell sharply last year, has stabilized but shows few signs of increasing rapidly. Moreover, stock prices have been falling, hurting both consumer and business confidence, and many corporate executives remain gloomy about their firms' prospects for improved profitability.

The latest economic data, such as a 0.9 percent drop in retail sales last month, have generally been weak, except for various housing sales and construction reports, which remained strong.

Yesterday, the Commerce Department reported that the nation's trade deficit rose in April to a record $35.9 billion, as imports rose twice as fast as exports. Analysts said the import figures were additional evidence that the U.S. economy is expanding, but also that an increasing share of the demand for goods and services in this country is being satisfied by foreign producers. The slower rise in exports may be an indication that foreign economies' growth is lagging behind that of the United States, analysts said.

On the basis of the recent numbers, economists at Macroeconomic Advisers, a St. Louis forecasting firm, have lowered their estimates of growth in the current quarter to around a 2 percent annual rate, less than half the first-quarter pace.

"Combined with the latest inflation data, which are largely benign, signs of weakness in spending and production make it increasingly unlikely that the Federal Reserve will commence with a sequence of interest rate increases as early as the Aug. 13 FOMC meeting," the firm told its clients this week.

"While a series of strong reports between now and then might persuade the committee to raise the target for the federal funds rate in August, we believe it is more likely that they will wait until at least September to begin raising rates," it added.

Peter Hooper, chief economist at Deutsche Bank in New York, thinks the FOMC will wait even longer.

"The downward revision of growth prospects is enough to move the most likely date for initial Fed tightening from September to November or even later," Hooper said, adding that won't happen until growth becomes strong enough to begin to reduce the current 5.8 percent jobless rate. The latest statistics "tell us the Fed will very likely not see that evidence this summer," Hooper said.

Economist Bob Ried of Ried, Thunberg & Co., an investment research firm in Westport, Conn., said November is the earliest the Fed will move, but he doesn't expect it to raise rates until next year.

"In these parlous times, the Fed can hardly afford to upset the apple cart with a premature tightening of monetary policy," Ried said. "Unless the economic outlook improves considerably, the inflation outlook worsens measurable, and financial conditions stabilize, the first tightening might not come until next year."

© 2002 The Washington Post Company

Posted by DeLong at June 20, 2002 09:10 PM

Comments

I remember nothing but rosy predictions earlier in this year - not just from investment bank salesman ^H^H^H^H^^H stock analysts, but everybody - including this site, earlier.

It surprised me, that it was actually hard to find pessimism, considering that there were actual reasons for pessimism - the fact that the economy was being sustained by irrational levels of consumer spending, that Bush was playing Voodoo II, that the political situation in the Middle East was uncertain, Al Qaida possibly active, price-earnings ratios still bubbly.

Barry

Posted by: Barry on June 21, 2002 06:51 AM
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