Washington, DC, May 4--The Federal Reserve moved a step closer toward raising interest rates for the first time since 2000, saying strong economic and jobs growth has defused the deflationary threat that preoccupied the central bank for a year.
The Fed's monetary-policy committee on Tuesday voted unanimously to keep the key federal funds rate at 1%, where it has been for the last ten months. It indicated the risk of deflation has passed, saying prices are now just as likely to rise as fall. Still, the panel said it is likely to be "measured" about raising interest rates because inflation still is low.
"Output is continuing to expand at a solid rate and hiring appears to have picked up," the Federal Open Market Committee said. But "at this juncture, with inflation low and resource use slack, the committee believes that policy accommodation can be removed at a pace that is likely to be measured."
The phrase "likely to be measured" replaced an earlier formulation in which the committee said it "can be patient" about raising rates.
"Although incoming inflation data have moved somewhat higher, long-term inflation expectations appear to have remained well contained," the committee said.
The decision was widely expected on Wall Street. Since the committee last met in mid-March, government statistics have shown a clear improvement in U.S. economic performance: Economic growth accelerated in the first three months of 2004, and non-farm employers created jobs at an average pace of 171,000 a month. A key measure of inflation, meanwhile, rose to the top of the range the Fed deems desirable.
The central bank, as a result, has begun preparations to reverse the extraordinary stimulus it gave the economy over the last three years. During that time, the Fed cut the funds rate to its lowest level since 1958, driving house purchases to record levels and spurring waves of mortgage refinancings. It held the funds rate at that level long after the economy started to grow rapidly in 2003 because policymakers were worried that declining inflation rates could lead to outright deflation.
Inflation rates, however, have been climbing steadily this year. The core price index for personal consumption expenditures--the measure that Fed policymakers pay the greatest attention to--rose at a 2% annual rate in the first three months of 2004. That's the upper limit of the 1% to 2% range that Fed policymakers consider healthy. "The threats of deflation, which were a significant concern last year, by all indications are no longer an issue before us," Fed Chairman Alan Greenspan told U.S. lawmakers last month.
Fed policymakers, as a result, have begun to consider how they will restore the federal funds rate to a level appropriate for an economy that's neither growing too fast nor too slow. One former Fed governor, Laurence Meyer, says that "neutral" level may be as high as 4.5%, which would imply the FOMC would have to raise interest rates rapidly to keep inflation from lurching outside the desirable range. Economic policymakers in other countries fear rapid increases in U.S. rates could imperil the global economic recovery.
Several Fed policymakers, however, have said the central bank isn't yet in a position where it would be forced to raise the federal funds rate rapidly. For one thing, they say, there is no agreement about what constitutes a "neutral" funds rate. Besides, the Fed under Greenspan has shown a marked preference for gradual changes in interest rates--partly because such changes allow policymakers to minimize the risk of economic disruptions.
