Federal Reserve needed to check inflationary pressure

July 1, 2004

Folks with adjustable-rate loans or seeking mortgages won't be happy about it, but the Federal Reserve was right yesterday to begin to nudge up interest rates. It had held them at modern lows while the economy was sluggish, but with vigorous growth resuming, the time to act to forestall future inflation is now.

Although price pressures remain modest, the Fed can't wait for the economy to overheat to act; if it does, it risks having to take far more painful action in order to wring inflationary pressures back out of the economy.

The Fed Open Market Committee's action was no surprise: It had been widely expected to push up its basic interest rate by a quarter point, which is exactly what it did - signaling that it was prepared to raise rates more when the economy needs additional restraint. Financial markets rewarded the action by boosting stock prices.

With the nation posting economic growth at a nearly 5 percent rate over the most recent 12 months, it was time.

Borrowers may be glum, but the economy has subsisted too long on the strength of consumers borrowing against their homes or other assets. That has helped keep the 2000-2001 recession a relatively mild one, but that couldn't go on indefinitely.

Too much borrowing leaves households vulnerable to reversals of fortune. Eventually homeowners must pay off a second mortgage on their houses. The economy thrives more reliably on growth than by simply drawing down its present assets.

Besides, a quarter percent bump in interest rates is in itself hardly going to disqualify anyone from making a new house loan; at 1.25 percent, the key Fed rate is still at an extraordinary low. In the boom years of the '90s, it ran around 5 percent - and not only did the economy perform better than it had in decades, but home ownership boomed.

Even in the '80s, when federal deficits were huge, the Fed's key interest rates of 7 or 8 percent didn't prevent vigorous economic growth. As the economy continues to warm, and barring some catastrophic event, interest rates will creep up further. But they have far to go before they become a worry.


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