Crucial news will steer Fed’s actions

Kane Loukas

As far as the economy is concerned, this week is an important one for every U.S. consumer and investor.
This morning the latest Consumer Price Index data will be released by the Bureau of Labor Statistics and U.S. Department of Labor. The numbers tell people if they should brace themselves for a move by the Federal Reserve to slow the economy.
Students would be acutely impacted by such a move. A slower economy means fewer jobs, lower wages, and, if inflation has its way, higher rates on student loans.
Today’s CPI report indicates the inflation rate for May. It will be scrutinized very closely because of huge inflation in April. Economists expect that inflation in May rose 0.2 percent. If today’s report is higher than 0.2 percent, it will be a sign of a serious upward trend, not just a blip on the economic radar screen.
The inflation rate in April was 0.7 percent, well above the 0.4 percent expected by experts, and it struck a shockwave across U.S. financial markets. It might not sound like much, but over the course of a year 0.7 percent per month turns into 8.4 percent, roughly twice the inflation rate during the past several years.
Bungee cord economics
A high rate of inflation has several effects. The most important is that prices rise, which is exactly what inflation indicates. When this happens, it simply takes more money to buy most, but not necessarily all, items.
Inflation can also have a negative impact on investments, the competitiveness of U.S. businesses and wages. But, in some cases, inflation is favorable. Minnesota farmers, for instance, might want inflated commodity prices because it will put more money in their pockets.
Tobias Madden, a regional economist with the Minneapolis Federal Reserve Bank, said long-term inflation projections are more telling of economic conditions than short-term movements. Students shouldn’t be concerned with the broad economic picture, but should look at those prices that have a direct impact on their spending habits, he said.
“I think students are more concerned about the price of education,” Madden said. “If they’re into bungee jumping, it’s the price of bungee cords. Or, if they ride their bikes, they don’t care as much about gas prices,” — one of the major elements in the CPI. An increase in housing costs might also be a big concern for student renters, he said.
The cost of low inflation
Some inflation is livable. Every economy has it and the United States, with high growth and low inflation, has a better amount than most.
What might not be as livable — especially for Americans grown accustomed to collecting the generous spoils of the boom economy — are the steps taken by the Federal Reserve to quell inflation and, in effect, put the brakes on the economy.
The Federal Reserve’s tool of choice is the short-term interest rate, known officially as the Federal Funds Rate. In the last 12 months, the rate was decreased from 5 percent to 4.5 percent, where it currently stands.
The rate directly affects the amount of interest banks and other institutions pay for short-term loans.
When those interest rates go up, stock prices tend to fall, corporate borrowing is curtailed, and consumers might be inclined to cut back on spending.
Markets have, in fact, already made adjustments in expectation of a rate hike. Since April’s inflation figures were released on May 14, the Dow Jones Industrials has shed 4.3 percent and the technology heavy Nasdaq has given up 6.7 percent.
The Greenspan factor
The go-ahead for an interest rate increase will come from Federal Reserve Chairman Alan Greenspan. On Thursday in his hearing before the Congressional Joint Economic Committee, Greenspan is likely to signal that interest rates will indeed see an increase.
During a separate hearing earlier this week, Greenspan noted that U.S. productivity, a main ingredient of a successful economy, isn’t likely to maintain its ongoing level.
He said the amount of output per hour of work has been growing at an annual rate of around 2 percent since 1995, double the annual gains of the previous two decades.
“The growth of productivity cannot increase indefinitely,” Greenspan said. “While there appears to be considerable expectation in the business community, and possibly Wall Street, that the productivity acceleration has not yet peaked, experience advises caution.”