This may be end of Fed's economic therapy

September 21, 2005|By JAY HANCOCK

Hello, summer 2001. That's the last time the Federal Reserve's interest rates were this high.

It was pre-9/11. Before the invasions of Iraq and Afghanistan. Before Isabel and Katrina. Before "ground zero" was much more than disaster-movie lingo.

The stock market was a little hinky, and the Fed saw "economic weakness." Little did it know it was the lip of an economic and emotional crater we have been negotiating ever since. In response to continuing weakness that some feared would morph into depression, the Fed had slashed its short-term, overnight, "fed funds" rate to 1 percent by 2003, the lowest since the 1950s, flooding the nation with cheap, easily borrowed money.

Now the Fed has finally cranked the overnight rate back to 3.75 percent, where it stood in June and July of 2001. Perhaps this is the other side of the crater. Perhaps we should celebrate the end of therapy and the Fed's estimation that the economy is strong enough to proceed without a turbo-powered gurney.

Trouble is, it doesn't feel like we're there yet.

Even before Katrina hit, the country was producing jobs at a sub-par rate and output in some sectors was declining. Now consumer confidence has plunged, near-term prospects for energy supply and prices are discouraging, and one of America's chief commercial cities lies empty of almost everything but scum and mud.

The central bank's decision yesterday to raise rates by a quarter percentage point surprised some analysts who believed the blow from Katrina trauma and $3 gas might induce it to stay its hand.

Maybe the Fed was worried about inflation and bent on eventually getting the overnight rate to 4.5 percent, these economists suggested. But they thought it at least might pause in the relentless monetary tightening begun last year, to gauge damage from recent events.

But the Fed's official statement said it saw "robust underlying growth in productivity." Although it forecast that the "widespread devastation in the Gulf region, the associated dislocation of economic activity, and the boost to energy prices" would hurt for a while, it asserted that "they do not pose a more persistent threat."

Not everybody on the Fed's Open Market Committee agreed, however. Mark W. Olson is a former president of the American Bankers Association who was nominated to the Fed board by President Bush in July 2001, just before the economy got into serious trouble. Yesterday, he was the only member voting to keep rates unchanged, the Fed disclosed.

Perhaps he was thinking of the so-so 169,000 jobs created in August - a figure below analysts' expectations. Maybe he was worried about the pre-Katrina plunge in August retail sales of 2.1 percent - double what economists had expected.

Maybe he was thinking about consumer confidence, which declined after the hurricane to its lowest point since 1992, below its readings even during the darkest days after the terrorist attacks and corporate scandals of 2001 and 2002.

Rhetoric was the only acknowledgment the Fed gave yesterday to the recent problems. The statement murmured about "unfortunate developments," "the tragic toll" and so forth. However, one piece of yesterday's verbiage might signal an easing of rate increases down the road.

For months, each time after the Fed predictably ratcheted up the overnight rate by a quarter point, it would declare: "Even after this action, the stance of monetary policy remains accommodative." That's Fedspeak for "rates are still too low, and you should expect more increases."

Yesterday's statement was slightly different. It dispensed with the "even after this action" emphasis and referred to "accommodation" in a glancing, less direct way. "Monetary policy accommodation," the communique said, "coupled with robust underlying growth in productivity, is providing ongoing support to economic activity."

Well, as they say in Chappaqua, N.Y., what is the meaning of "is"? Does it refer to rates before yesterday's tightening or after? Are rates still "accommodative"? Does the dropping of the "even after this action" phrase mean we're getting to the beginning of the end of accommodation and thus ever-higher rates?

Fed Governor Mark W. Olson seems to hope so.

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