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On August
22nd, the Federal Reserve, our nation's central bank, decided not to raise
short-term interest rates. As most people already know, the Federal
Reserve has been tightening credit conditions over the past year.
As a matter of fact, the Fed has raised interest rates six times during
this period. By doing so, the Federal Reserve was attempting to cool
down the economy and prevent inflation from spiraling out of control.
Why did the Fed decide not
to tighten at its August 22nd meeting? The reason the Fed decided
to back off at the time is of course related to information coming out
about the economy. Even though economic activity continues to expand,
there are indications that the pace of expansion is slowing. In other
words, there is evidence that the past tightening by the Fed is starting
to take hold.
Consumer spending, which
accounts for two thirds of all activity, is reportedly slowing in several
parts of the country. Moreover, retail activity appears to be leveling
off in most parts of the country. The Fed also reports that manufacturing
activity is showing signs that it may be slowing. Given the tighter
credit conditions it comes as little surprise that construction activity
is also operating at a slower pace. This holds true for both residential
and nonresidential construction. Statistics generated by the Federal
Reserve also suggest that while bank lending across the country continues
to expand the pace is far from alarming.
The Federal Reserve, and
anyone with a passing interest in the economy, knows that labor market
conditions are very tight throughout the country. There is evidence
to suggest that wages and benefits have been growing. However, it
appears that gains in productivity have largely offset this pressure.
Thus, inflationary pressure resulting from wage and benefit increases appears
to be in check. Moreover, the Federal Reserve is now forecasting
that inflation will run in the 2.50 to 2.75 percent range for the remainder
of the year, and that GDP growth will moderate over the last part of the
year.
The evidence at this point
in time suggests that past Federal Reserve actions have had the desired
effect of moderating aggregate demand to a level that more closely matches
the ability of the economy to produce goods and services. However,
the Federal Reserve has indicated while the current situation looks promising
the economy is not yet out of the inflationary woods. Even though the probability
of future interest rate hikes has lessened, the Federal Reserve has made
it very clear that it will not hesitate to raise rates at the first sign
of building inflationary pressure. However, given that this is a
presidential election year there is little likelihood that the Federal
Reserve will raise rates before November. To do so would compromise
the Fed's stature of being a politically neutral organization. |
