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Slowing US Economy

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.

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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.


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