The Fed Must Alter Operating Procedure to Relieve Deflation

In anticipation of the Federal Reserve Board meeting tomorrow, Empower America co-director Jack Kemp released the following statement:

“There is widespread speculation that when the Fed meets tomorrow, it will cut the fed funds rate on overnight money that banks lend to one another by another 25 basis points, to 1.75 percent. In my opinion, more interest-rate-targeting gradualism of this sort will not succeed in reversing the monetary deflation currently underway and will fail to re-ignite the economy to lift it out of recession.

“Rather than more of the same interest rate targeting, the Fed tomorrow should announce that it is changing its operating procedure. Rather than targeting interest rates, the Fed should announce that it will allow the market to set interest rates while it buys US Treasuries until market prices stop falling and rise back to non-deflationary levels.

“As David Gitlitz, chief economist of TrendMacrolytics points out, Fed Chairman Alan Greenspan’s favorite inflation/deflation gauge, the core personal consumption deflator which overstates inflation, is now rising on a three-month moving average basis by only about 1.2% a year, down from about 2% a year ago. The Dow Jones Spot Commodities Index has fallen 12 percent this year and the CRB Futures Index is off 16 percent. The price of oil has plummeted to near $18 a barrel. The price of gold has dropped back to the neighborhood of $272, the already-deflationary level to which it had fallen prior to September 11. Not only are auto dealers losing money selling automobiles at zero-percent financing, some retail stores selling high-ticket electronics, such as flat-screen TVs, have taken up the practice of offering zero-interest/no-payment terms until January 2003.

“Until the Fed recognizes that falling prices are the cause, not the consequence, of the economic downturn, it will continue to squeeze the economy into further contraction.”

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