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March 23, 2005

Fed Funds Rates at 3.75% by Year's End

Andrew Balls of the FT writes about the Federal Reserve's interest rate policy. The Fed's language has led the market to mark up its expectations of end-of-year Fed Funds rates from 3.5% to 3.75%:

FT.com / World / US - Fed signals concern on inflation: The US Federal Reserve on Tuesday signalled increased concern about inflation, as it again raised interest rates by a quarter point to 2.75 per cent. The rise was widely expected, and the policymaking Federal Open Market Committee said it expected to continue raising rates at a ‘measured’ pace, generally interpreted to mean quarter point increases. But the central bank held out the possibility that it might have to move more aggressively to curb inflationary pressures, or at least to continue with quarter-point increases for longer than investors had been expecting.

‘Though longer-term inflation expectations remain well contained, pressures on inflation have picked up in recent months and pricing power is more evident,’ the statement said. The FOMC said it saw the risks to growth and inflation as roughly equal. But, in contrast to its statement in January, it made clear that this judgment was based on ‘appropriate monetary policy action’....

Futures markets, which had priced in a federal funds rate of about 3.5 per cent at year-end, increased this to 3.75 per cent, Mr Hooper said...

I'm beginning to understand the Fed a little better. I've tended to focus on falling real wages and wage shares as indicating that we are still very far from full employment, and that rapid increases in interest rates are inappropriate. The Fed is focusing much more on non-wage causes of increasing prices, and is very concerned not to get into a position where fighting inflation requires large and sudden interest rate increases in the context of a financial system that is much more fragile than we would like. Better higher unemployment now than even a chance of running into a conflict down the road between risking a financial crisis and letting inflation accelerate.

Posted by DeLong at March 23, 2005 01:12 PM