What the Fed giveth, it may soon have to taketh away
2 hours, 3 minutes ago
Looking at Wall Street on Tuesday, you could easily believe that the mortgage crisis and credit crunch so much in the news lately had evaporated over night. The market rallied 336 points, its biggest one-day gain in nearly five years, after the Federal Reserve slashed short-term interest rates by half a percentage point, meeting the optimistic predictions.
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The move should give a jolt to an economy weighted down by housing and credit woes. It should reduce some borrowing costs for individuals as well as companies. But it's more a temporary catalyst than an enduring remedy. Enjoy it while it lasts.
Though it's impossible to say what will happen next, one thing is clear: Federal Reserve Chairman Ben Bernanke does not have the luxury to repeatedly slash rates that his predecessor, Alan Greenspan, once did. The threat of inflation makes sure of that.
Greenspan had the good fortune to run the Fed at a time of low energy prices and surging worker productivity. He realized that this made it possible to stoke the economy through low rates without stoking inflation.
But good times have a way of bringing on their own demise when leaders refuse to face changing realities and unchanging truths. Inflation is a problem in part because of countries such as China and India. After two decades of growth, they are buying more stuff — from oil and steel to iPods and memory chips — helping to push up prices. Their workers are also demanding higher wages to produce the goods and services that make their way to Western nations.
The problem is one of our own making, too. As Americans have grown accustomed to good times, they've bought bigger homes and bigger cars. They've borrowed and consumed more, sometimes stretching themselves to the limit. Their government, meanwhile, has not only failed to encourage prudent polices on personal savings, energy consumption and other matters, it also has gone on its own borrowing, spending and tax-cutting binge. By juicing the economy when it didn't need it, government limits its ability to do so if and when the need arises.
For these and other reasons, let us hope that a recession is not in the offing. Neither the Fed nor the nation's political leaders have much ammunition to use against it.
In fact, the Fed might soon have to start raising rates to focus more on inflation as it did in the late 1970s and early '80s, setting the funds rate, its key economic lever, at an inflation-whipping (and economy-wrecking) 20%. It is now 4.75%.
Greenspan said in a Monday interview with USA TODAY that inflationary pressures will force the funds rate back into double digits in coming years.The technical term for that is: ouch!