The Federal Reserve System (the Fed) is the central bank of the United States which was founded by Congress in 1913. Its primary responsibilities are conducting the nation's monetary policy; supervising and regulating banking institutions and protecting the credit rights of consumers; maintaining the stability of the financial system; and providing certain financial services to the U. S. government, the public, financial institutions, and foreign official institutions (www. federalreserve. gov).
The Fed consists of twelve administrative districts and banks inclusive of major cities across the United States. Each of these Federal Reserve Banks gathers information regarding the current economic conditions for their respective areas which is summarized by district and sector in the Beige Book. The Beige Book is published eight times a year and the overall report from the twelve districts is prepared by a designated Federal Reserve Bank on a rotating basis.
These reports are based on economic data from seven major categories: Consumer Spending, Manufacturing, Real Estate & Construction, Tourism & Services, Banking, Natural Resources & Agriculture, and Labor Markets, Wages, & Prices. As I mentioned earlier, one of the duties of the Fed is conducting monetary policy. One of the most important tools in doing this is the adjustment of the interest rates it charges member banks to borrow money. The Fed analyzes the findings in the Beige Book to determine the interest rate policy.
Take the January 2004 Beige Book report, some key information contained in this summary might affect the Fed's decision to maintain interest rates. Though the overall report suggested that the nation's economy had improved since the last survey, some areas continued to report very little or no improvements in certain areas. In consumer spending, holiday retail sales were generally upbeat across the country, especially during the last two weeks of 2003. However, Cleveland, Chicago, Dallas and St. Louis, four very large cities, reported only slow, modest or mixed growth.
The Fed needs to evaluate the contributing factors for this sluggish economic period in these cities. Now, the unemployment rate in these areas may be the reasoning behind this slump in sales. The employment rate in the retail and other service areas may have grown tremendously, but approximately 8. 3 million Americans were unemployed in January (www. chicagotribune. com). Assumedly, the consumer spending and the labor market, wages, and prices categories go hand-in-hand. Consumers can not spend money if they are not making money.
The same goes for the Banking and Real Estate & Construction categories, home mortgage lending continued to fall due mainly to lower refinancing activity and commercial real estate activity remain weak. Based on these results, in my opinion, the Fed can do two things; maintain the current interest rates in hopes that the economy will bounce after the New Year and as new jobs are developed and the unemployment rate decreases. Or the Fed can lower the interest rates which will prompt its member banks to borrow more money. In turn, the member banks could offer loans to consumer and businesses (especially small business) at lower interest rates.
Furthermore, hopefully, future reports will reflect positive results in these categories. Since the latest Beige Book report (January 14, 2004), several articles have been written about the current economic conditions and interest rates. BBH & Company reported that sales were limited in the Northeast due to inclement weather. They also stated that an important but often ignored economic driver is demographics. The Department of Commerce reported the U. S. population reached 292 million in 2003 which will cause greater demand for products such as disposable diapers, homes and automobiles.
Additionally, BBH & Co. concludes that significant idle capacity and little inflation risk should lead the FOMC (Federal Open Market Committee) to hold rates steady. Yet another article from www. boston. com stated that the Federal Rserve did not want to upset the economic recovering, thus, they held the short-term at 1 percent, a 45-year low. However, the Fed did hint that rates could move higher in the future. The Fed said that since its last meeting in December, economic reports suggest that the economy is "expanding briskly.
" It added that "although new hiring remains subdued, other indicators suggest an improvement in the labor market" (www. boston. com - Associate Press). It seems that in order for the Fed to control inflation they will take into account several factors. According to the reports, overall, the economy is improving, some areas more slowly than others, but there is evidence of some improvement across the country. Also, the Fed is hopeful that more jobs will be developed in the coming months which will boost the economy as well. Therefore, consumers will begin spending more money and businesses' sales will increase.
Moreover, the Fed realizes that maintaining the current interest rate will allow businesses and consumers to bounce back from last year's economic condition. As stated in the article from the Associated Press, 'the Fed's decision to leave the funds rate alone means commercial banks' prime lending rate for many short-term consumer and business loans remains at 4 percent, the lowest level in more than four decades. An environment of low short-term borrowing costs may give consumers and businesses an incentive to spend and invest more, boosting economic growth.
' From Federal Reserve chairperson, Alan Greenspan and the FOMC, maintaining the current interest rate at 1% will help hold down borrowing costs on business and household loans, stimulating continued spending and economic growth (Washington Post). This reasoning supports my perspective regarding maintaining the current interest rates. I do believe, however, as other economists would agree, that once there is evidence of a solid, definite boost in the economy, Greenspan and the FOMC will adjust and raise interest rates substantially.
The most important factors in the Fed's interest rate decision can be best described in a statement from FOMC, "with inflation quite low and resource use slack, the committee believes that it can be patient in removing its policy accommodation" (BBC News). The policy accommodation, by the way, is holding the current interest rate until a noticeable change in the economy occurs. Many economists expressed their interpretation of this statement from the FOMC. The various perspectives from each economist hold rue to the old economist joke: "When you put four economists in a room, you get eight different opinions.
" In the situation with the Fed's statement regarding the interest rate, I can understand how such a variation of opinions is derived. One could assume that the Fed meant the current rate will remain steady for an unspecified period of time. Conversely, one could assume that this was the Fed's way of preparing its constituents for an adjustment in their monetary policy. I think an economist's role is to analyze financial data as it becomes available and develops opinions from both a consumer and business perspective.
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