Monetary Policy, Interest Rates, and Federal Reserve

The Federal Open Market Committee of the Federal Reserve System has maintained short-term interest rates at 1 percent, but is preparing financial markets for a retreat from its current "cheap" money policy. The most recent statement from the FOMC has strengthened expectations among analyst that the Fed might actually start to increase borrowing costs before the upcoming presidential election.

Tom Schelesinger, executive director of the Financial Markets Center, a nonprofit research group in Philomont, Virginia, said, "The Fed feels confident that it has the autonomy and the built-up political capital to do what it thinks is right." Fed Chairman Alan Greenspan continues to make it clear that he is willing to increase rates if economic conditions warrant, regardless of the fact that it is an election year.

Recent conditions indicate that economic growth is strengthening and inflation may be growing. This condition is what economists call an "inflection point". When the Fed determines this condition to be present, they shift their priority from pumping up a weak economy (warding off recession) to preventing the economy from overheating (discouraging inflation).

Laurence E. Meyer, a senior adviser at Macroeconomic Advisers and a former Fed governor, stated that the debate within the Fed seems to have shifted to a position that favors future interest rate increases to prevent potential overheating.

In a report to Congress last month, Mr. Greenspan indicated that the Fed was no longer worried about deflation. In this most recent report, the FOMC is indicating that monetary policy will proceed at a "measured" pace toward higher rates.

(Updated July, 2004)