Analysis: Fed may not be as lucky in 2005
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Date: Monday, December 06, 2004 11:36:59 AM EST By SHIHOKO GOTO, UPI Senior Business Correspondent
WASHINGTON, Dec. 6 (UPI) -- From higher oil prices to a weakening dollar, and ever-growing budget and trade deficits, there have been plenty of issues that have kept Federal Reserve policymakers on their toes this year. But when the Federal Open Market Committee meets for the last time this year on Dec. 14, its members including Fed chairman Alan Greenspan are likely to be patting themselves on the back for a job well done throughout the year.
For Fed watchers, though, a nagging question for next year remains: who could replace Greenspan when his term on the board expires on Jan. 31, 2006? For whoever succeeds Greenspan, not only will it be difficult to follow in the shoes who has dominate the U.S. economy for the past two decades, but there will likely be bigger macroeconomic issues to grapple with.
Certainly, there were plenty of downside risks, but while the year started off with concerns of the U.S. economy overheating and the Fed not moving quickly enough to preempt too rapid an expansion, the greater threat to immediate growth now is increasing inflationary pressure.
The U.S. central bank began the year with the federal funds target rate at 1.00 percent. Since then, the benchmark rate has been doubled to 2.00 percent, and many analysts expect the Fed to raise it yet again one last time this year to 2.25 percent. But while the central bank has largely succeeded in keeping steady growth at home in addition to holding the inflation rate under control, there is growing concern that the central bank will have a far more difficult time achieving its delicate balancing act of ensuring growth and price stability next year.
Some, of course, argue that the probability of the Fed continuing to raise interest rates steadily next year as a sign of strong economic recovery in the United States, pointing out that the central bank's tightening stance is an indication of more growth to come.
But the less optimistic analysts are wont to argue that the central bank will be forced to raise rates to stay ahead of mounting inflationary pressure. Yet higher rates will lead to a slowdown and perhaps even lead to a slump in U.S. economic growth next year.
There is no doubt that the key issue that concerns economists these days is the prospect of petroleum prices remaining considerably high. Granted, crude oil futures prices have come down considerably since their peak at over $50 several weeks ago. Nevertheless, it's still too early to say that global energy costs will continue to slide from their highs, given the still-tumultuous situation in the oil-producing Middle East on the one hand, and the very real problem of increased energy demand from developing countries which will only continue to grow on the other.
According to the International Monetary Fund, every $5 increase in oil prices leads to a fall in global GDP by 0.3 percentage points, as it makes it more costly for manufacturers to produce goods, and households find more of their income being spent on fuel. Not only that, higher oil prices would likely cut into business investments, and it would also possibly lead to a slump in consumer sentiment, which would further dampen growth prospects.
But global oil prices, which is largely outside the control of the U.S. government, isn't the only factor that could thwart the nation's growth prospects next year. Indeed, in a speech at a European Central Bank conference in Frankfurt late last month, Greenspan made a point of emphasizing the risks of an ever-growing U.S. trade deficit and the resulting weakening of the greenback in particular.
"It seems persuasive that, given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point," which could elevate the cost of financing the deficit, the Fed chairman warned.
Since then, the greenback has continued to fall steadily against major currencies, and it is still reaching record lows against the euro on a regular basis. That has increased concerns about the over-dependence of the U.S. economy on foreign investors, and the vulnerabilities that brings with it.
But macroeconomic risks won't be the only issues the central bank will be grappling with next year. The naming of Greenspan's successor later next year will have implications far beyond the walls of the Fed and indeed Washington, as the head of the Federal Reserve is one of the most influential, if not the most influential, figures in international financial markets. While the position is politically independent, President Bush will have the authority to name his person of choice, who then must be confirmed by the Senate.
And whoever Bush names, the incoming Fed chairman will have plenty of issues to grapple with, not least to reassure international financial markets of his or her ability to deal with the many challenges facing the U.S. economy. |
