Interest Rates and Deficits

A Call To Action
The New York Times
December 18, 2004
EDITORIAL


Alan Greenspan did what he had to do last Tuesday, raising interest rates for the fifth time in a row by a quarter point, to 2.25 percent, and leaving little doubt that the increases would continue. But whether the Federal Reserve's rate-setting committee will be able to stick to its self-described "measured" pace is an open question. Much depends on decisions that have more to do with fiscal and trade policy, the domain of President Bush and his merry band of weak-dollar-big-deficit policy makers, than with monetary policy, the domain of the Fed. That's because the administration's policies exert upward pressure on prices and interest rates, risking what a recent Fed staff report on trade imbalances calls "wrenching changes."

The Fed has to raise rates because continued low rates would only contribute to a glut of dollars, further inflating real estate values and, eventually, other prices as well. At the same time, however, the Fed must contend with the inflationary pressures inherent in the administration's weak-dollar policy. The administration believes that it can rely on a weak dollar to fix America's huge trade imbalance, thereby avoiding the more fundamental fix of reducing the huge federal budget deficit. But a weak dollar runs the risk of inflating the prices of all goods, not just foreign ones, because as imports become more expensive, domestic producers raise prices in tandem.

Moreover, the outsized deficits require huge infusions of capital from abroad, and that need could also lead to higher interest rates as the Treasury attempts to lure lenders to our heavily indebted shores.

Against this backdrop, measured interest-rate increases may someday seem a luxury - and that someday could be soon. In a report issued on the day after the Fed's latest rate increase, the Treasury Department reported that money flowing into the United States - capital that is crucial to finance our deficits - plummeted in October to $48.1 billion, a 12-month low. It was the seventh decline this year out of the 10 months for which data has been collected, and that is a bad omen for America's continued ability to finance its deficits on the terms currently being offered.

Meanwhile, higher interest rates hurt job creation and wages. A majority of working Americans have never participated fully in this economic recovery, now more than three years old. The need to raise rates before employment and wages have rebounded is another indication of an economy off-kilter.

The Fed's attempt to be "measured" is imperiled by the administration's willingness to risk "wrenching changes." The wrenching change the country really needs is to move away from profligacy and toward a semblance of balance in fiscal and trade matters.

Copyright 2004 The New York Times Company