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Predicting Growth, Fed Lifts Key Rate

By Nell Henderson
Washington Post Staff Writer
Wednesday, August 11, 2004; Page A01

Federal Reserve officials yesterday expressed confidence that the economy will regain momentum in the months ahead and raised a key short-term interest rate to ensure inflation remains under control.

Fed policymakers, in a statement issued after their meeting, blamed high energy prices for the recent sharp slowdown in economic growth and job gains. They made clear they still view that "softness" as temporary and believe they can likely stick to their plan of lifting rates gradually as the expansion continues.

Video: Washington Post financial reporter Nell Henderson discusses the Federal Reserve's decision and its potential impact on the markets.
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Transcript: Jared Bernstein, senior economist at the Economic Policy Institute, discussed the Federal Reserve decision on interest rates, unemployment, stocks and oil prices.
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Federal Reserve Open Market Committee Statement (August 10, 2004)

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Graphic: Historical Changes in the Federal Funds Rate
In His Own Words: Greenspan comments and Fed actions since 2001.
Timeline: Interest rate changes since the recession of 1990.
Graphic: Greenspan's economy during boomtime.
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Federal Reserve Special Report
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Interactive Graphic: Economy Over History
Report: The U.S. Economy

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The Fed's action appeared to dismiss concerns that the economic recovery is faltering again, just months before a presidential election that could hinge on perceptions of the economy's health. While presidents in the past have urged the Fed to keep rates as low as possible, President Bush characterized the Fed's last rate increase, in June, as a sign the economy is getting stronger.

But critics said that by blaming oil prices for the recent dip in economic growth, the Fed was playing down the role of weak job and income growth in cooling the economy.

Stock prices scored their biggest gains in two months following the Fed's action, as many investors were more heartened by the Fed's optimistic outlook than they were worried that higher interest rates will slow growth. The Dow Jones industrial average gained 130 points, or 1.3 percent.

The economy "appears poised to resume a stronger pace of expansion going forward," the Federal Open Market Committee, the central bank's top policymaking group, declared in its statement.

The committee's emphatic language indicated the Fed would maintain its plan for a series of gradual rate increases in the face of growing uncertainty about the economy's underlying strength. Some analysts argue that the recent economic slowdown simply reveals weaknesses masked in recent years by tax cuts and the Fed's own interest rate policies. Continuing to raise rates in such an environment, they contend, risks undermining the recovery.

Fed officials agreed unanimously to nudge their federal funds rate -- the interest rate charged between banks on overnight loans -- to 1.50 percent from 1.25 percent. The rate influences many other business and household borrowing costs throughout the economy.

Banks responded to the Fed announcement by raising their prime lending rate for business loans to 4.50 percent from 4.25 percent. That means consumer rates that are tied to the prime rate, such as many home-equity loans and credit cards, will likely rise by as much.

But rates are still so low by historical standards that they should continue to stimulate economic growth by encouraging borrowers to take on more debt. The central bank did not raise rates to slow the economy, but rather to ensure that inflationary pressures do not build. Lifting them by a small amount at this point is more like easing up on the economy's accelerator than like tapping the brake.

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