Strategy

Fed Raises Rates Despite Katrina

The story might be different, however, at the next meeting of the Federal Reserve, in two months.
Stephen TaubSeptember 20, 2005

The Federal Reserve has continued its tightening policy by raising the federal funds rate another 25 basis points, to 3.75 percent. This is the 11th hike in the fed funds rate since June 2004.

A minority of experts thought the Fed might pause until its next meeting, in two months, given the effects of Hurricane Katrina. A statement by the Federal Open Market Committee, however, asserted that output appeared poised to continue growing at a good pace before the storm struck.

“The widespread devastation in the Gulf region, the associated dislocation of economic activity, and the boost to energy prices imply that spending, production, and employment will be set back in the near term,” stated the FOMC. “In addition to elevating premiums for some energy products, the disruption to the production and refining infrastructure may add to energy price volatility.”

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The committee acknowledged that these developments have increased uncertainty about near-term economic performance, but it stressed that that they “do not pose a more persistent threat.” Rather, added the statement, “monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity.” The committed also noted that “higher energy and other costs have the potential to add to inflation pressures. However, core inflation has been relatively low in recent months, and longer-term inflation expectations remain contained.”

The FOMC added that with underlying inflation expected to be contained, it believes that policy accommodation can be removed at a “measured” pace. “Nonetheless, the committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.”

In a related action, the Board of Governors unanimously approved an increase in the discount rate of 25 basis points, to 4.75 percent.

Before Hurricane Katrina devastated the Gulf, there was little doubt that the Fed would raise rates once again. But in the days leading up to Tuesday’s meeting, some economists speculated that the Fed would hold off for a month in light of the region’s massive loss of jobs and resulting decline in economic activity. Consumer spending, these experts observed, has accounted for about two-thirds of the growth in the overall economy.

On the other hand, the rapid post-Katrina run-up in energy prices spooked many inflation worrywarts. Many experts also pointed out that the huge sums earmarked for rebuilding the devastated areas would offset other declines in economic activity.

Speaking with the Associated Press before the latest rate-hike announcement, Economy.com chief economist Mark Zandi observed that at the Fed’s next meeting, in two months, it may leave the fed-funds rate as is. “In November, there will be a lot of ugly economic data out on Katrina’s initial impact,” noted Zandi, “and that might make it harder for them to move at that time.”