Federal Reserve announced
static interest rate at 5.25%

by Crystal Gottfried

For those of you who missed it, the Federal Reserve suspended its two-year campaign of raising interest rates, on August 8, hoping that a modest economic slowdown would subdue inflation.

The central bank voted to hold its benchmark interest rate stead at 5.25 percent after 17 consecutive increases since June 2004 because policy makers said that wanted more time to see where the economy was headed before deciding on further increases.

In their statement which accompanied the decision, the Federal Reserve board acknowledged that inflation had accelerated, but predicted that slowing economic growth dominated by the decreased housing market would lead to smaller consumer price increases soon.

“Readings on core inflation have been elevated in recent months,” the Fed’s policy making committee said. “However, inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.”

The Fed left itself enough room to resume its rate increases in case inflation proves more stubborn than expected, but it implied that the hope was to avoid any more increases for the near future.

This move comes at a “risky” time when still modest inflation is being stoked by surging oil prices that are now accompanied by rising costs for materials and labor. At the same time, it is hoped that this policy change would ease inflationary pressures but not enough to cause a big jump in unemployment.

At the same time that the unemployment rate is creeping up, economic growth has slowed sharply, and productivity growth, the primary determinant of overall prosperity and the indicator of healthy growth without rising prices, has stalled.

Many economists said that they disagreed with the Fed’s outlook. They say that prices and wages are both climbing significantly faster than a year ago, and have showed no signs of slowing yet.

Just hours before the Fed made its announcement, the Commerce Department reported that the biggest component of production costs, workers’ compensation, climbed at a yearly rate of 5.4 percent in the second quarter of 2006. In that same time period, unit labor costs, the cost of labor necessary to produce a given amount of output, were 3.2 percent higher; this is the biggest jump in almost five years.

Although some economists think that the Fed’s move was essentially a finish to this round of interest rate increases, many others argue that the Fed was correct to leave interest rates alone.


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