Productivity is rising, jobs are disappearing and inflation is tame, so interest rates are staying the same.

The Federal Reserve kept short-term rates unchanged, and signaled that it will keep rates low until prices begin to rise. That might take months because inflation might not arrive until the economy starts creating jobs instead of shedding them. And with American workers becoming more productive each month, employers have little reason to hire.

"The Committee continues to believe that an accommodative stance of monetary policy, coupled with robust underlying growth in productivity, is providing important ongoing support to economic activity," the rate-setting committee said. "The evidence accumulated over the intermeeting period confirms that spending is firming, although the labor market has been weakening. Business pricing power and increases in core consumer prices remain muted."

The Fed's rate-setting Open Market Committee kept its target for the federal funds rate at 1 percent. The prime rate will remain at 4 percent. Some types of consumer debt -- such as auto and home equity loans -- are based on the prime rate and thus will change little if at all. Rates for long-term, fixed-rate mortgages respond to broad economic factors, so they won't necessarily remain steady just because the Fed kept short-term rates steady.

On the lookout for deflation
Members of the Fed's rate-setting panel have found themselves in the unusual position of inviting inflation. They want inflation to stay for a brief visit before they send it away, but higher prices haven't knocked on the door yet.

They seek a modest return to inflation because the economy is uncomfortably close to its obstinate opposite, deflation. It's difficult to fight deflation, which is a broad decline in prices that discourages consumers from buying things. Inflation is easier to combat: Just raise interest rates. The Fed has decades of experience doing that.

For years, the Fed has had a policy of heading off inflation at the first hint of higher prices. This time, the rate setters want to look it in the eye and smell its breath, just to make sure it's really there, before banishing it. Instead of trying to prevent inflation -- the usual course -- the Fed plans to react to inflation. For now, deflation poses a bigger danger.

"The committee judges that, on balance, the risk of inflation becoming undesirably low remains the predominant concern for the foreseeable future. In these circumstances, the committee believes that policy accommodation can be maintained for a considerable period."

"Accommodation" is the Fed's term for keeping interest rates low.

When inflation returns, it will be accompanied by more jobs. That welcome prospect seems remote right now -- the unemployment rate is 6.1 percent, and the economy has shed an estimated 437,000 jobs this year. Since employment peaked in February 2001, at 132.6 million jobs nonfarm jobs, about 2.8 million jobs have disappeared from the U.S. economy.

Productivity and jobs
One element of the terrible job picture is the amazing productivity of the American worker. As employees produce more per hour of work, employers can put off hiring. From April through June, worker productivity increased at an annual rate of 6.8 percent. Many economists expect the economy to rally in the second half of the year and grow at an annual rate of 4 percent to 5 percent, but it won't increase employment if productivity matches the rate of economic growth.

Doug Duncan, economist for the Mortgage Bankers Association, predicts strong economic growth the rest of this year and into 2004, but believes that the unemployment rate will barely budge, ending up at perhaps 5.7 percent at the end of 2004. "I expect not dramatic, sudden changes, but a steady improvement in employment," he says.

Until the Fed sees that steady improvement, and inflation returns, it is likely to keep short-term interest rates low.