All quiet on the Fed front

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No one believes the Federal Reserve’s open market committee will change short-term interest rates today.

Alan Greenspan and his posse of central bankers meet every six or seven weeks to decide interest rate policy, wielding the federal funds rate as their main tool. The federal funds rate, also known as the overnight lending rate, has stood at 1.75 percent since December, after 11 straight rate reductions in 2001. Virtually everyone expects the rate to remain at 1.75 percent after this meeting.

When formulating interest rate policy, the open market committee ponders an array of economic statistics, including the rates of inflation and unemployment. With inflation low and unemployment rising or at least steady, few would argue for raising short-term interest rates right now.

In the 12 months that ended May 31, the Labor Department measured inflation at a measly 1.2 percent. An ebullient Greenspan used the Q-word to describe it.

“The underlying, remarkably quiescent inflation outlook to me, in my judgment, is a positive factor, and I suspect the American economy is in an upswing,” Greenspan said in early June at a banking conference in Montreal.

Quiescent means quiet and inactive, like a pierced and tattooed teenager on a family vacation to the Grand Ole Opry.

In the same speech, Greenspan added that he doesn’t expect a dramatic upswing, but that “events look increasingly positive.”

Things truly look positive for the overall economy, but they don’t look so upbeat for the 8.3 million unemployed people. The unemployment rate usually peaks well after an economic recovery begins because businesses tend to work their employees harder before hiring new people. That describes today’s situation. Indeed, Greenspan likes to cite American workers’ rising productivity when he talks about the economic recovery. Unfortunately for the unemployed, rising productivity encourages businesses to hold off hiring new workers.

The unemployment rate reached a seven-year high in April, at 6 percent, and dropped to 5.8 percent in May. A one-month drop doesn’t make a trend, and members of the open market committee don’t treat it as one.

At the same Montreal conference in which Greenspan spoke, an open market committee member opined that April’s 6-percent unemployment rate might not mark the high point. Robert McTeer, president of the Federal Reserve Bank of Dallas, said: “I suspect it will rise a bit more before turning down.” He added that today’s economy “bears some resemblance to the so-called jobless recovery after the 1990-91 recession.”

More recently, Fed Governor Susan Schmidt Bies has made similar remarks, saying that she doesn’t feel certain that April will prove the high-water mark for the unemployment rate. Bies sits on the open market committee.

These statements by Fed members hint that the committee has no plans to raise interest rates this month. Most economists expect the Fed to hold rates steady at least until the Sept. 24 meeting, and some expect no rate change until 2003.

The futures market at the Chicago Board of Trade predicts Fed policy quite accurately. The futures market has priced in a slim chance of a rate increase through August, and less than a 20 percent chance of an increase to 2 percent through September. Futures traders seem confident that the overnight rate will rise to at least 2 percent by the end of December.

Banks pay one another the federal funds rate for overnight loans. The Federal Reserve controls the rate indirectly by adding and subtracting cash from the banking system.

The overnight lending rate influences other interest rates, most importantly the prime rate, which banks charge to their best and biggest customers. The prime rate stands at 4.75 percent. Lenders base rates for some credit cards, auto loans and other kinds of debt upon the prime rate. Long-term mortgage rates don’t respond directly to changes in the overnight rate. Instead, they loosely follow the ups and downs of the yields paid on 10-year Treasury notes.