South-Western College Publishing - Economics  
The Long Term Prospect For Inflation
Subject Prospects for Interest Rates
Topic Employment, Unemployment, and Inflation
Key Words

Inflation, Federal Reserve Policy, and Recovery

News Story

Economic growth has soared in the third quarter of 2003 at an annual rate of 8.2 percent and most forecasters agree that the economy will grow by at least 4 percent in 2004. This scenario would normally see the Federal Open Market Committee of the Federal Reserve applying upward pressure on interest rates to head off any inflationary tendency in the economy. But, Fed officials have made it clear that they have no intention of raising rates anytime soon. They continue to offer cheap money to the economy by keeping interest rates at an all time low.

Construction of new homes, which many forecasters had expected to decline, continues to run at near record levels. Shipments of manufactured goods, orders for new equipment, and business confidence have all been up indicating a strong growth prospect for the future. Fed officials have focused on two particular variables, the stubborn rate of job creation and the near absence of inflation.

With the job numbers looking better, the Fed will become more focused on the outlook for inflation, and they are expected in the next meeting of the Federal Open Market Committee to reiterate their position that interest rates can remain low for a "considerable period". To the surprise of many, the core rate of inflation, excluding prices for food and energy, actually slowed to a rate of only 1.1 percent last year.

"Federal Reserve officials will convene next week amid growing signs of potentially spectacular divergence between economic growth and inflation prospects," said Robert DiClemente, a senior economist at Citigroup. "Fundamentals point to a period of very low inflation, keeping the F.O.M.C. sidelined next week and well into the future."

To date, the only concrete evidence of inflation has been the sharp rise in prices for commodities ranging from oil and gold to farm products and steel scrap. But those price increases have not translated into higher producer prices or higher consumer prices and until they do the Federal Reserve appears content to wait it out.

(Updated March, 2004)

Questions
1.

What type of policy does the Fed use to control economic activity?

2. Who serves on the F.O.M.C.?
3. Use the Internet to find the most recent measure of the consumer price index as a measure of inflation.
Source Edmund L. Andrews, "A Recovery unlike Others Seems to Alter Fed Rate View", The New York Times Online, January 26, 2004.

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