Practice Final Exam for Modern Political Economy, PE 101, Fall 2007
Starting to Think About Next Semester's Teaching...

Tim Duy Thinks the Federal Reserve Will Hold Interest Rates Steady

He writes:

Economist's View: Fed Watch: Set to Hold Steady: [W]ithout additional evidence that that the housing downturn is contributing to excess weakness in other parts of the economy, the Fed can take a pass in October. Is their any chance the Fed will start to think about reversing the September move? Not very likely.... [T]he Fed will not change course with the financial markets on edge. Yes, I know that moderate growth coupled with a variety of warning signs on inflation make the case for a reversal, but the Fed simply could [not] care less.... This is Fedspeak for “sell the Dollar, we don’t care.”... The Fed will be watching for official inflation, core PCE inflation. They are not ready to respond to the falling Dollar or rising commodity prices; I believe they are more complacent on inflation than the obligatory “inflation risks” clause would lead you to believe, and perhaps rightly so... to date, inflation by their measures is not a problem, and while the steepening yield curve points to some worries among market participants, it does not suggest that inflation has gotten away from the Fed.

For my part, the global economic landscape continues to leave me a bit unsettled. Commodities have resumed their upward surge, with oil now above $86 and gold exceeding $760. The Baltic Dry Freight Index is rapidly moving to new highs. The Chinese stock market is going stratospheric. The IMF has written off the Dollar, although the G7 will most likely say something Dollar supportive this weekend. And, probably worst of all, I see a strong chance that all of these trends will build through the 2008 Olympics – all at the same time that credit market concerns keep the Fed in neutral with an easing bias.

For now, however, all is good. Be happy.

In short, solid incoming data erased fears of imminent economic destruction, as well as my expectation for a rate cut this month (watch the data turn against me again).... [I]f the current pace of data is maintained, the Fed will be content to sit tight at 4.75%.

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