The Federal Open Market Committee, the policy making arm of the Federal Reserve, meets today. The panel will decide whether or not to change the federal funds rate, the interest rate banks charge one another for overnight loans and the rate over which the Fed exercises much control. For some time, the weight of the evidence has suggested that an interest rate cut is in order, and the Fed would be wise to reduce the current federal funds rate of 5.5 percent by at least half a percentage point.
The conduct of monetary policy has never been an exact science. This is further complicated by the fact that any significant impact that monetary policy has upon output and spending builds up gradually and takes several quarters to be fully felt. Policy makers must consider not only current economic and inflationary conditions but also those on the horizon. In both cases, the argument for lowering short-term interest rates is persuasive.
Since the Fed last adjusted the federal funds rate - it increased it by one quarter of a percentage point in March 1997 - consumer-price inflation and economy-wide inflation have fallen. In the twelve months before March 1997, consumer prices increased by more than 3 percent. In the past 12 months, consumer prices increased by 1.7 percent. Considering the CPI's upward bias, which Fed Chairman Alan Greenspan has estimated could be 1.5 percentage points, the Fed has, for all practical purposes, achieved its long-sought goal of price stability. Indeed, in each of 1998's first two quarters, a broader price measure - the GDP chain-type price index, which considers price changes among all the components of the economy's output - has reflected annualized inflation rates below 1 percent, compared to the nearly 3 percent rate that prevailed during 1997's first quarter when the Fed last raised the federal funds rate.
Meanwhile, the producer price index, which measures the prices of goods in various stages of production and somewhat forecasts later consumer-price inflation, has actually declined during the past 12 months, indicating deflationary forces. …