The Fed Can Afford to Be "Patient"
By Rich Miller
Federal Reserve Chairman Alan Greenspan likes to describe his approach to monetary policy as a "risk management" strategy. The aim: to downplay the dangers of particularly bad outcomes for the economy, be they a surge in inflation or a collapse in demand. Under such a strategy, the Fed at times deliberately errs on the side of an easier or tighter policy to reduce the risks to the economy.
So what does that mean for the Dec. 9 meeting of the central bank's policymaking Federal Open Market Committee (FOMC)? It means don't expect much change in the policy statement that the committee issues afterwards. Sure, Greenspan and his colleagues are likely to tweak the language to take note of the economy's marked improvement since they last met on Oct. 28 (see BW Online, 12/4/02 "Will Greenspan Shift Gears?"). But the message on monetary policy will be basically the same. With inflation low and unemployment high, the Fed can afford to be "patient," in Greenspan's own words, when it comes to raising interest rates.
ANEMIC JOB GROWTH.
There's no doubt that Fed policymakers have become more optimistic about the economy since their gathering six weeks ago. And why not, given the spate of sparkling data released since then, from the astounding 8.2% growth of gross domestic product in the third quarter to the surprising strength of the manufacturing sector in November. In the so-called Beige Book that the Fed itself prepared for Tuesday's meeting, the central bank called the improvements "reasonably broad-based."
Yet the risks of a relapse, while clearly receding, remain, at least in the eyes of some Fed officials. Holiday sales have so far been muted. And while the job market has at last turned up, it's far from healthy. In November, companies added just 57,000 workers to their payrolls, far below the 150,000 or so considered normal by Fed officials. "The risk that the economy will again stall out must be given a smaller probability than assigned just a few months ago, but the risk cannot be discounted completely," Fed Vice-Chairman Roger W. Ferguson said in a speech in Chicago on Nov. 21.
Meanwhile, inflation remains quiescent. Excluding volatile food and energy costs, consumer prices have risen just 1.3% in the year ended in October. Sure, commodity prices are going up, and the dollar is weakening, putting upward pressure on import prices. But labor costs – the biggest expense for business by far -- are falling, thanks to productivity's startling performance.
Unit-labor costs for nonfarm businesses fell 5.8% in the third quarter as productivity soared 9.4%, its fastest rise in 20 years. Indeed, with output per worker so strong, unemployment still high, and many companies operating well below capacity, some Fed policymakers still fear that already rock-bottom inflation could fall further to undesirably low levels.
Plenty of good news can be found as well. Like the economy, the financial markets look to be on much firmer ground than they were earlier in the year. Stock prices are at their highest levels in well over a year, with the Dow Jones Industrial average within hailing distance of the 10,000 milestone and the Nasdaq composite flirting with 2,000.
Thanks to the Fed's promise of continued easy money, bond prices have bounced back after collapsing over the summer on fading deflation fears. Yet liquidity in the financial markets generally tends to dry up late in the year, as Wall Street brokers and institutional investors close their books. That makes the markets susceptible to volatile swings, a risk, analysts say, that the Fed would be better off not courting by making major changes in its message now.
Far better to wait until next month, when the markets are more active and the Fed will have a better reading on the crucial holiday sales season. After its December meeting, the FOMC will gather again on Jan. 27-28 for an in-depth look at the economy and to discuss monetary policy. If Greenspan & Co. want to signal a significant shift in their thinking, that's the time to do it. Not on Dec. 9. The risks argue against it.
Miller covers the Fed from BusinessWeek's Washington bureau
Edited by Douglas Harbrecht