The Federal Reserve has won the war. Now it has to win the peace.

The war was the long struggle against inflation. Now that the Fed has crushed inflation, it must watch out for two peacetime perils: renewed inflation on one side, and disinflation on the other.

Fed chairman Alan Greenspan declared victory over inflation in April, when he told the House of Representatives that “further disinflation would be an unwelcome development.” That declaration was “as close to high drama as we get in conducting monetary policy,” said Fred Broaddus, who sits on the rate-setting Federal Open Market Committee and is president of the Federal Reserve Bank of Richmond, Va.

In a speech to bankers July 25, Broaddus added: “Now that we have price stability, however, we at the Fed have a new task: to sustain it. I never thought much about sustaining price stability back in the bad old high inflation days.”

He will have time to think about it today, when the rate-setting committee meets, because he won’t have much else to do. There will be no drama, high or low. No one seriously expects the Fed to change short-term rates up or down. The rate-setting committee seems content to watch inflation and disinflation duke it out to a draw. Both are weak, anyway.

The federal funds rate, which is what Fed-member banks charge one another for overnight loans, will remain at a 45-year low of 1 percent. The Fed cut it from 1.25 percent to 1 percent at the rate-setting committee’s latest meeting, June 25. The prime rate, which is what banks charge their best corporate customers, will remain at 4 percent.

Other interest rates, too, have remained steady since the Fed’s last meeting, with just a few exceptions. The average rate on a fixed-rate credit card is down about half a percentage point, but the average rate on a variable-rate card is up by about half a percentage point. Yields on one-year to two-and-a-half-year certificates of deposit are mostly unchanged, although the average yield on a 5-year CD has inched up from 2.52 percent to 2.70 percent.

Car loans are unchanged, and rates on home equity loans and home equity lines of credit have crept down slightly in a delayed reaction to the Fed’s quarter-point rate cut.

No, rates haven’t changed much since the last time the Fed met, except for mortgage rates. To say that they’ve gone through the roof would make for a charming play on words, but it wouldn’t be quite accurate.

Rates on 30-year, fixed-rate mortgages have gone up by more than a percentage point, from 5.31 percent to 6.43 percent. That’s still very low by historical standards; over the last five years, the 30-year mortgage rate has averaged 7.06 percent. Over the last 10 years, the average is 7.37 percent; and since 1985, when Bankrate.com began surveying mortgage rates, the average is 8.40 percent.

Rates on 15-year fixed mortgages have gone up about a percentage point since the Fed last met, to an average of 5.78 percent; and rates on one-year adjustables are up about four-tenths of a percentage point, to 4.10 percent. Those rates are still low by historical standards.

The Fed has given no hints that it is worried about the increase in mortgage rates, even though Greenspan and other members of the rate-setting committee are fond of talking about how the housing sector and the refinance boom kept the economy afloat during the economic downturn that started right around the election controversy of 2000.

Ironically, a lot of observers say the Fed was responsible for the rise in mortgage rates. When the rate-setting body cut short-term rates by one-quarter of a percentage point June 25, long-term rates immediately went up because bond investors had expected a half-point cut. Then, in early July, Greenspan told Congress that it was unlikely the Fed would use unconventional methods to combat disinflation. Investors took that to mean that the Fed wouldn’t buy long-term Treasury notes to force down rates, and that resulted in a sell-off of Treasury notes that caused rates to rise.

That double whammy turned into a triple whammy when the complex market in mortgage-backed securities forced Treasury yields even higher, which caused mortgage rates to rise, which caused Treasury yields to rise, which caused mortgage rates to rise even more.

“I don’t know if the Fed meant to trigger such an increase in long-term rates,” says Michael Carliner, economist for the National Association of Home Builders. “They may say something to calm the market in that respect, but what they can do about that is unclear.”

Now that the Fed has whipped inflation, it has to make sure that the housing industry doesn’t become collateral damage.

— Updated: Aug. 12, 2003