fed may leave rate steady

found this since my own opinion just posted.

bloomberg.


Fed May Leave Rate Steady, Debate Cost of Reducing Inflation

By Craig Torres

Sept. 20 (Bloomberg) -- Federal Reserve policy makers will probably keep interest rates unchanged for a second month today as they remain divided over the costs of clamping down on inflation.

The Fed's case for doing nothing is strengthened by reports yesterday showing a plunge in home building and a drop in wholesale prices. The economic cost of continuing to attack inflation after a two-year tightening may be too high for some officials, including San Francisco Fed President Janet Yellen. At least two of the Fed's dozen district banks have opposed her stance.

The debate boils down to competing ideas about how inflation works and the consequences of reducing it, Fed-watchers say. Most Federal Open Market Committee members appear worried about the impact on consumer spending and jobs if rates are pushed higher. Dissenters warn that falling behind on inflation will do greater harm.

``The majority of the committee is willing to let inflation hold above their target for a while,'' said Stephen Stanley, chief economist at RBS Greenwich Capital Markets in Greenwich, Connecticut. ``There are others who believe the inflation genie is so dangerous that if it was out of the bottle, the costs ratchet up exponentially.''

Stanley predicts the Fed will lift borrowing costs in October, even after figures yesterday showed the first back-to- back decline since 2002 in producer prices excluding food and energy. Economists at Bear Stearns Cos., Lehman Brothers Holdings Inc. and Bank of Tokyo-Mitsubishi UFJ Ltd. concur.

The Fed will announce its decision at about 2:15 p.m. in Washington and will keep its benchmark rate at 5.25 percent, according to all 109 economists surveyed by Bloomberg News. The Fed lifted rates 17 times from June 2004 though June this year.

Labor Costs

Inflation is elevated and appears to be spreading into labor costs. So-called core prices rose 2.4 percent in the 12 months ending July, as measured by the personal consumption expenditures price index minus food and energy, the Fed's preferred yardstick. Over the past three months, the gauge increased at a 2.7 percent annual rate.

``There are many signals of inflation risk,'' said Ethan Harris, chief economist in New York at Lehman. ``The Fed is basically forgiving all the energy-cost pressure that's crept into prices of other goods and services.''

Unit labor costs rose 4.9 percent in the second quarter from a year ago after gaining 9 percent in the first three months, the biggest back-to-back increases since 2000, and a sign of a classic inflation cycle, said Allen Sinai, president of Decision Economics Inc. in New York.

``Price stability does not exist in the U.S. today,'' said Sinai.

Policy Tradeoff

Yellen, who defended the decision to stop raising rates in August, told reporters in Boise, Idaho, on Sept. 7 that a rapid reduction in inflation ``can be damaging to the economy.'' ``There is a tradeoff,'' she added.

Yellen argues the Fed can be patient because the public's optimism that prices can be contained is well-anchored.

Richmond Fed President Jeffrey Lacker, who opposed the August decision, and Philadelphia Fed President Charles Plosser - - whose board voted for a discount-rate increase prior to the last meeting -- are more likely to focus on the risks that inflation expectations rise, according to economists who have worked with both men.

For Lacker and Plosser, what inflation does in the future depends on what the Fed does and says now. A rate increase soon and a reiteration of an inflation goal could bring prices down with little cost to jobs and production because expectations would quickly adjust.

Distinction

``The distinction between Yellen and Lacker seems to be about whether they think long-term inflation expectations are completely anchored or not,'' said Brian Sack, senior economist at Macroeconomic Advisers LLC in Washington.

``If you believe they are, then the FOMC can take a patient approach,'' Sack added. ``If you instead think that expectations are not anchored, and will respond to higher inflation rates, then the FOMC can't afford to wait long.''

Key to the FOMC majority's view is a slowing economy. The San Francisco Fed's forecast shows growth slowing to below 3 percent for at least the next two years, creating slack that will cause the core PCE index to fall to 2 percent by the end of 2008, according to the bank's Web site. Unemployment, according to the forecast, should drift up to around 5 percent at the end of 2007, and 5.25 percent by the end of 2008, from 4.7 percent in September.

Basis of Difference

Lacker said in an Aug. 30 interview that his own forecast was similar to the FOMC majority. The difference comes down to how expectations work.

Lacker's worry is that as long as inflation hovers between 2 and 2.5 percent, the public may begin to conclude that is the rate the central bank is really trying to achieve.

``Monetary policies are judged on taking action or not taking action against extreme uncertainty in forecasts,'' said Marvin Goodfriend, a former Richmond Fed adviser who teaches economics at Carnegie Mellon University in Pittsburgh, Pennsylvania. ``The questions are where the risks lie in being slightly tighter or slightly easier.''

To contact the reporters on this story: Craig Torres in Washington at [email protected] .