South-Western College Publishing - Economics  
Will the Fed Move Aggressively?
Subject Inflation
Topic Monetary Policy
Key Words

Inflation, Interest Rates, and Monetary Policy

News Story

As the watchdog for inflationary trends in the economy, the Federal Reserve has not had much of a battle to fight for the last fifteen to twenty years. Now new signs of inflationary pressures are softening the Fed's prevailing stance about interest rates. With the federal funds rate remaining at 1 percent for many quarters, the Fed has continually argued that inflation is not a serious problem. The Fed has described its strategy as one of "measured" increases in short-term interest rates over the long term. Recently, however, Alan Greenspan, chairman of the Federal Reserve, has suggested that sharper increases in interest rates may be necessary and warned consumers and businesses not to count on the "measured" response that Greenspan had offered in earlier speeches.

The Fed's initial view is based on a judgment that Greenspan says he still holds: Inflation is not likely to become a significant problem. "Should that judgment prove misplaced, however," Mr. Greenspan said in a speech delivered by satellite videoconference to a gathering of bakers in London, "then the Fed is prepared to do what is required to fulfill our obligations to achieve the maintenance of price stability."

"The speech invited speculation that the Fed could raise rates more aggressively," said Robert DiClemente, chief domestic economist for Citigroup Global Markets. "But Mr. Greenspan also said that the intention at the moment is to move in a measured way."

So, how aggressively will the Fed move to head off inflation? It is still very difficult to tell from various Federal Reserve officials' statements. Many private analysts express concerns that the Fed is moving too slowly and showing too much complacency with respect to inflationary pressures. However, Fed governor Donald Kohn suggested that inflationary pressures were still relatively mild. Greenspan backed that assessment, but also accepts the possibility that the assessment could be wrong. "Cost pressures have been relatively subdued," he said. "Nonetheless, the persistence of the rise in energy prices is a worrisome element in the cost picture. "

In the final analysis, it is the Fed's responsibility to achieve and maintain price levels. Most people agree that the Fed under Mr. Greenspan's leadership stands ready to fulfill that obligation, but at this point it appears the Fed strategy is still one of slowly increasing rates, as opposed to aggressive increases that some critics are demanding. Answering questions from bankers in the videoconference, Greenspan said, "So far, we have no reason to believe we will not be able to maintain a measured pace in the elimination of what we presume to be at his stage an unnecessary degree of accommodation."


(Updated August, 2004)

Questions
1.

When Greenspan speaks of the worrisome element on the cost picture, he is referring to a concept economist call cost-push inflation. Define cost-push inflation and give examples from your own life.

2. How do higher interest rates slow inflationary pressures?
3. Another type of inflation is demand-pull inflation. Define demand-pull inflation and give examples from your own life
Source Louis Uchitelle, "Greenspan Warns of Rapid Rise in Rates if Fed Sees the Need", The New York Times Online, June 9, 2004.

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