COMMENTARY COVERSHEET

Economics Commentary Number: #3

Title of Extract: Feds Lacker Says Slowing Economy Requires Lower Interest Rates

Source of Extract: http://economicnews.ca/login.php?page=reportsDetails&newsid=43031

Date of Extract: January 18th, 2008

Word Count_______ words

Date the Commentary was written__________________________

Section (s) of the syllabus to which the commentary relates: Section 3

Candidate Name: Juyeon Song

Candidate Number____________________________________________________
The US economy has been slowing down lately due to housing industry contraction, credit market
tightening and rising unemployment. Consequently, consumer spending is lower, driving down
aggregate demand. The current situation discourages consumers to spend as not enough money is in
the consumers pocket.

The slowdown in the economy requires several factors to bring it back up. As a result, the Federal
Reserve recently cut down the interest rate. This will stimulate the economy because lower interest
rate means cheaper loans, which will trigger more borrowing of funds by consumers, more investments
made by businesses, and overall increase in interest- sensitive spending. This will cause people to spend
more. Meanwhile, the problem is that lowering interest rate will increase inflation. Although Central
Bank said that they will balance those two issues through monetary policy, and the long term inflation
looks stable since the fluctuations are up and down, the short term reality is different, in that food and
energy price keeps elevating inflation higher, even above the core inflation rate. Because of the inverse
relationship between interest rate and inflation, meaning if the interest rate is lower, consumer
spending will increase which will result in higher price level of goods, controls of adjustments to interest
rate and inflation should be made quickly. It was also suggested that the Bank should keep a watch on
consumer expectation.

In addition to the solutions provided in the article, the economy would grow again with changes in the
fiscal policy. If the government reduces both individual taxes and business tax, consumers and
businesses would have more disposable income. If that happens, consumers will spend more money
because they pay less, and businesses will produce and sell more and also invest more. This would shift
the aggregate demand to the right. Unlike the monetary policy, the fiscal policy is easier to control
because it involves only the decision by the government and direct changes in spending habits of
consumers and business, whereas reduction in interest rate will affect many industries in the economy
and have indirect effects throughout the economy.

Another suggestion to this problem is to encourage exporting which will bring in more foreign money
into the economy. With the increase in exporting , importing will also be encouraged because of the
countries relationships with each other. Thus, to increase domestic prices relative to foreigh prices,
this effect only works when exporting is higher than importing, so that Net export is positive.

Factors that a country does not have any control over which could also alter aggregate demand in our
favour are foreign income changes, and exchange rates. In order to shift aggregate demand to the right,
foreign countrys income must be lowered. That way, exchange rate will be lower which will encourage
exporting by businesses and consumer spending.
Feds Lacker Says Slowing Economy Requires Lower
Interest Rates (Update)
09:17 01/18 (CEP News) Washington The slowing pace of the U.S. economy requires the
Fed to lower interest rates, but inflation pressures also present risks, Richmond Fed Bank
President Jeffrey Lacker said Friday.

Speaking at the annual meeting of the Risk Management Association in Richmond, Va.,
Lacker echoed many of the themes presented by his Federal Reserve System brethren over
the past week.

The economy is slowing, pulled down by the weight of a housing industry contraction, credit
market tightening and rising unemployment. Those pressures will require the central bank
to lower the federal funds rate to stem the downward slide, he said.

A slowing economy requires a lower real interest rate because it means softer relative
demand for resources now compared to the future, Lacker said. And the current downside
risks mean that further slowing, and thus further easing, is quite possible.

Throughout the past week, Fed officials have echoed the same theme. The U.S. economy is
in trouble, but inflation remains a worry. The central bank will have to balance those two
issues through monetary policy, even if, as some analysts expect, it lowers rates short term
before pushing them back up to keep inflation in check.

Lacker acknowledged the Feds concern about inflation. Inflation also presents risks, he
said. Throughout the period since 2005, when inflation rose, eased off, then rose again,
longer-term inflation expectations have remained fairly stable.

However, as energy and food prices continue to push overall inflation above core inflation,
the higher overall trend could work its way in the consumer inflation expectations, further
complicating monetary policy, Lacker said.

Speaking to reporters after his remarks, Lacker, a self-described inflation hawk, said the
monetary policy has to keep an eye on inflation as well as economic growth.

I still feel as if inflation is higher than Id like to see, Lacker said. I still feel inflation has
to be a factor in our policy setting. I dont think its sensible policy to set inflation on a
shelf.

Fed Chairman Ben Bernanke has suggested in recent remarks that while the Fed will be
flexible and quick in adjusting interests rates downward to address economic slowness, the
central bank may be just as flexible and quick in pulling rates back up if inflation numbers
deteriorate.

Lacker said he does not expect to see runaway inflation, but a key will be keeping
consumer inflation expectation in check. He does not think the Fed is in danger of
overshooting with interest rates and causing a spike in inflation.

As to the general economy, Lacker said that in addition to the housing slowdown, equally
worrisome is cooling in the commercial real estate market. Commercial real estate is not
encouraging in terms of pulling back from projects, he added.
By Steve Campbell, scampbell@economicnews.ca, edited by Nancy Girgis,
ngirgis@economicnews.ca

(END) CEP Newswires - CEP News Ltd. 2008. All Rights Reserved.
www.economicnews.ca

Related recent stories:

(21:10 01/28) U.S. President Bush Urges Patience on Economy in State of the Union
Address
(16:48 01/28) The Day Ahead Canada & U.S.: U.S. Durable Goods, Consumer Confidence
(16:46 01/28) Sovereign Wealth Funds Are of Great Benefit to U.S., Says Treasury's
Kimmitt