South-Western College Publishing - Economics  
Let the "Jawboning" Begin
Subject Inflation
Topic Monetary Policy
Key Words

Jawboning, Inflation, Interest Rates, and Political Reaction

News Story

After over four years of a stable federal funds rate, the Fed finally increased the rate from 1 to 1.25 percent. This moderate increase signaled the recognition that inflation may be rearing its ugly head. The Democrats, headed by the Democratic Presidential nominee John Kerry, and the Republicans with President Bush's Administration both reacted to the announced rate change with caution. In fact, both parties began the process referred to as "jawboning" to draw Americans' minds to their own way of thinking.

On the Republican side, spokesman Scott McClellan said the rate increase was a reflection of the economy's strength. "As the economy grows and jobs are being created," he said, "I think it's always expected that a rate increase would be part of that strengthening in the economy."

Fed chairman Greenspan, a Republican himself (thought he has been praised as being unusually apolitical as he has served through both Republican and Democratic administrations), continues to be preoccupied with guarding against inflation and Fed policymakers are leaving room to dose the economy with stronger medicine if conditions warrant. The stated position, however, is that inflation is well under control. In the Fed's statement announcing the increased rate, the central bank reiterated its position. "Although incoming inflation data are somewhat elevated, a portion of the increase in recent months appears to have been due to transitory factors," the Fed said.

On the Democratic side, Kerry's campaign refrained from commenting on the Fed's decision, but did accuse Bush of setting the stage for higher interest rates in the future by moving the country from a budget surplus accumulated during the Clinton administration to a large and growing deficit during his term of office. President Bush inherited a budget surplus that quickly vanished with the war on terrorism and several rounds of tax cuts that may or may not have provided stimulus to the sluggish economy.

"Over the long term," said Gene Sperling, a top economic adviser to Mr. Kerry, "economists estimate that Bush's fiscal policies would raise long-term interest rates by about 1 percentage point higher, meaning that a typical family would have to pay $1,200 more for a home mortgage each year and $120 more for a student loan each year."

"The higher debt passed on to our children and the higher long-term interest costs [that] working families and American businesses will bear amount to a Bush debt tax and will require a new economic strategy," Mr. Sperling added.

The real economic question with respect to the rate hike is how quickly it will affect inflation and how far will the Fed have to go in the future with additional hikes. The political rhetoric, however, is likely to be more vague as each party questions the other's position and tries to convince the American public of their own "truth."


(Updated September, 2004)

Questions
1.

Create a definition of the term "jawboning" in your own words.

2. Political responses to economic events are often laced with value judgments. Use any source available to find a definition for "normative economics".
3. The change in interest rates by the Fed is part of monetary policy, but in their response, the Democrats referred to fiscal policy. Explain the meaning of each of these two types of policy.
Source Edmond Andrews, "Federal Reserve Raises Key Rate a Quarter Point," The New York Times Online, July 1, 2004.

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