South-Western College Publishing - Economics  
Higher Rates in the Future
Subject Interest Rates
Topic Monetary Policy
Key Words

Short-term Interest Rates, Long-term Interest Rates, and Inflation

News Story

U.S. inflation, although currently mild by most definitions, is running higher than it was just a year ago: exactly the situation that the Fed would like to avoid. Increasing oil prices have continued to exert inflationary pressures to the economy by making imports more costly. The weaker dollar has also added to the inflationary pressure by making foreign goods more expensive to American consumers.

Some analysts believe that cheap money is almost as plentiful now as it was before the Fed started on its campaign to continue increasing interest rates at a “measured pace”. This is one significant reason that the Fed will likely continue the strategy of gradually raising the federal funds target rate by small increments at each meeting.

Contrary to what most analysts expected under the Fed’s policy, and in spite of the fact that short-term rates have nudged upward five times since last June, the cost of home mortgages and long-term corporate financing has actually declined.

This persistence of low long-term rates has kept the American housing market much hotter than expected, and it has made it possible for companies to raise money cheaply for either expansions or acquisitions.

“Monetary tightening has not yet had an effect on the economy,” said David Hale, an independent economist in Chicago. “Credit spreads are tight, mortgage rates are low.”

Fed chairman Alan Greenspan is scheduled to testify before the House and Senate about the economy and monetary policy around February 16 th or 17 th. This will give the chairman an opportunity to signal the direction for future Fed policy.

“There is definitely a recognition that we need to get to a different setting, and the only question is how fast to go,” said Robert DiClemente, a senior economist at Citigroup. “The inflation outlook is manageable, as long as we keep moving.”

1. Discuss the concept of monetary tightening referred to in the article. How should money tightening affect housing markets and business expansion?
2. How does the weak dollar add to the inflationary pressures?
3. What is meant by the term “cheap money”?
Source Edmund Andrews, “Federal Reserve is Expected to Continue Raising Rates”, The New York Times Online, January 31, 2005.

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