Slowing US Economy
The article titled 'Fed Unlikely to Alter
Course' by John M. Berry of the Washington
Post takes an interesting look at
actions that Alan Greenspan his colleges of
the Federal Reserve have been
taking over the last 9 months to slow the economic
growth of United States.
The astonishing growth rate of 7.3% is fueled by an
economy that is in the
midst of a "high tech revolution". The article
also explores the contrasting
view of other economists that say that the Fed has
increased interest rates
too much in its attempts to slow the economy. The means
by which Alan
Greenspan and the Federal Reserve have chose to slow the economy
is through a
monetary policy, or more specifically, an increase in the national
interest
rate. The article states that the Fed officials have come to a
"broad
agreement that they will keep raising the rates until growth slows
to a more
sustainable pace to make sure inflation stays under control."
Because of
the booming economy and the investment in the stock market the
exchange of
money has increased for goods and services, which in turn increases
the price
level or the quantity of money demanded. By increasing the interest
rates the
Fed commits itself to adjusting the supply of money in the United
States
to meet that rate at a point of equilibrium. If the interest rate
is
increased, less goods and services are demanded, and therefore will slow
down
the economy and reduce the rate of inflation. The article points out
that as
"stock prices have risen over the last couple of years, so have
American
household wealth and consumer spending." This is precisely the cycle
that
Fed officials want to interrupt to slow growth before it fuels more
inflation.
At the time this article was written the stock market prices
had fallen sharply
especially in the technology sector. But the Fed continued
on the path to raise
interest rates further noting that the index that they
closely follow and
contains a broader rage of public traded US stocks, the
Wilshire 5000, is up for
the year. Even though they began raising rates
gradually 9 months ago, it takes
almost a year for the economy to feel the
full effects. In this case the results
of the interest rates increased could
be felt as last as the second half of
2000. Yet the economy has not
slowed down, and the demand for goods and services
continues to increase as
wealth does. One of the ideas that has been presented
to Greenspan by the fed
officials was to take bigger steps in raising the
interest rates. They feel
that this will decrease the money demand in a quicker
fashion. In turn these
actions will lead to lower consumer spending, and thus
decrease the inflation
rate. However, because of the erratic patterns in today's
high tech economy
Greenspan is expected to stick to his pattern of more gradual
increases to
the interest rate. Eventually when monthly loan payments increase
enough,
consumers will back on purchases and investments. The article points out
an
example where the rate for a new 30 year fixed-rate home mortgage is up
to
8.5% from 7.75% nine months ago in June. In the situation of a
$150,000 home
loan, this new interest rate will add almost $100 to each
monthly payment. Over
time the full effect of the interest rates will be
felt. One economist, James
Glassman of Chase Securities takes a different
look at the new interest rate. He
points out that the rates that the Fed has
set are fairly high in comparison to
the rate of inflation as it is currently
in the United States. The formula that
Glassman follows examines the
inflation rate when food and energy items are
excluded because they are so
volatile. With these items removed the rate of
inflation in the US is less
than 2%. As with other measurements, this rate can
be subtracted from the
interest rates to find a 'real' interest rate which
consumers a paying. So in
terms of 30-year home mortgage rate set at 8.5%, only
6.5% of it is what
the consumers are actually paying and the rest is accounted
for by inflation.
Glassman goes further to point out that "with inflation
so low, wages aren't
going up all that fast." To be said more specifically,
the interest rates are
increasing faster than consumers' wage increases. This
will eventually be
felt in the tightening of the American economy. However with
stock market
fueling the incredible momentum of the economy, the affects of the
interest
rate hikes have not yet been felt, and the question has risen to
whether or
not the Fed's tactics are actually going to work. However evidence
is
pointing back to when in 1995 the 'real' interest rate was close to 6.75%
and
the economy began to apply its breaks. Between that time in now a lot of
money
has been placed into the economy, and now to slow growth and inflation,
the fed
is using these high rates to take some of it away. Secrets of the CPI
The
article "Unveiling the Secrets of the CPI" by Kathleen
Madicgan
Focuses on exploring what exactly the Consumer Price Index is by
using some
recent examples from the United States economy. It delves into how
the rate of
inflation relates to the CPI and what tools the government uses
to predict
inflation. Moreover, it explores what happens when the government
incorrectly
predicts the rate of inflation. The U.S. government watches the
CPI as a way to
determine how fast the rate of inflation is growing. The CPI
is a good
measurement simply because it is an index of all the goods and
services used by
consumers in households, and is calculated on a monthly
basis. The goods and
services that are actually looked at come from a survey
of the past couple of
years. Usually economists look at the core rate of the
CPI, which excluded food
and energy prices, since they fluctuate so rapidly.
The article points out some
examples where the corn produced in the United
States could be directly affected
by the weather. Also the recent oil price
increases is directly related to OPEC
and their choice to cut back on the
production of oil. However the CPI is not a
perfect measurement as Alan
Greenspan, chairman of the Federal Reserve, has
acknowledged. It usually
overestimates the rate of inflation because the goods
looked at are from
previous years and do not include the addition of new
products into the
market. One example of this was the increase in cellular
phones over in the
1990's. The Bureau of Labor Statistics was not including them
in the price
index simply because they didn't seem to fit into one particular
category. So
how does the CPI relate to some of the current events in the U.S.
economy?
Kathleen Madigan writes about last April when the CPI was overestimated
by
analysts. When the CPI jumps sharply it suggests that rate of inflation
is
increasing. In April of 1999 the CPI jumped a sharp 0.7 percent suggesting
that
inflation was on the rise. At the same time market analysts anticipated
that the
Federal Reserve was going to increase the interest rates at the
beginning of
May. Because of this combination, the Dow Jones industrial
average tumbled
almost 200 points. If some one who borrows money in terms of
something such as a
home mortgage loan suddenly encounters unexpectedly high
increase in inflation,
the adjusted rate (the interest rate minus the
inflation rate) becomes
increasingly lower. Or in simpler turns, the money
that is paid back to the
lenders is less and less over time. Therefore more
money will be injected into
the economy and the wealth transfers form the
people lending the money to the
people borrowing the money. At this point the
Federal Reserve will have to step
in and raise the interest rates once again
to compensate for the inflation. It
is not bad for inflation to increase at a
steady rate, but when there is an
unusual spike in the rate, it hurts the
economy because when regulating interest
rates, it will take a long time to
feel the full effects. Another way of looking
at how the rate of inflation is
affecting the economy is in terms of the
earnings of many corporations. When
analysts predict the estimates for future
earnings, the rate of inflation is
figured into their calculations. However in
the case of April of last year,
the inflation rate as seen by the CPI increased
unexpectedly. Therefore the
earnings of many companies were overestimated, and
investors may have
"overpaid" for the price of a particular share of
stock. Conversely the bond
market yields were shown as increasing to a 12 month
high. This is accounted
by the yield rate being correlated to the rate of
inflation in the economy.
As the rate of inflation increases, so will the bond
yield rate to compensate
for inflation. In this case it makes the bond market
much more attractive to
investors considering the long-term yields may be higher
than other forms of
investment. It is also a benefit for the Federal Reserve in
the sense that as
investors choose to buy bonds, it will remove some of the
money supply from
the economy. Overall the Consumer Price Index is an important
tool provided
by the Bureau of Labor Statistics that the government looks at
closely to
determine the growth of the economy and value of money because of
inflation.
When there is an unexpected increase in this rate, the results
trickle down
to many outlets of the economy such as the stock and bond markets,
which can
be clearly seen by the sudden stock market fluctuation. In the last
year the
Federal Reserve began to regulate the economy by increasing interest
rates
because of the fear of rising inflation. Time will tell the effectiveness
of
these measures.