The Fed Case

One cannot argue that the economy, as it currently stands, is in distress. While there are different beliefs as to the primary cause, the "sub-prime" crisis has certainly played a key role. Predatory lending practices have finally caught up to financial institutions and businesses are feeling the effects. It's much more difficult now to secure financing, so businesses are being forced to forego expansion plans. In stark contrast to expansion, more and more Americans are out of work. The Department of Labor reports that approximately 8.5 million Americans are without work and unemployment has risen to 5.5 percent. Many companies are being forced to plan and implement eliminations to weather this stormy period and stay afloat.

Perhaps the place where consumers are feeling the strongest pinch is at the gas pump. On average, gas prices are nearly 40% higher, or almost $1.15 more, than year-ago levels. The price-per-barrel recently hit a new all-time high, cracking the $145 mark. And many experts are saying the $160 mark is not out of the question by years-end. There is an undeniable correlation between the rising gas prices and decreased spending. Many people are rethinking travel plans and are being forced to resort to public transportation for commuting to and from work. Unless we can cut our dependence on foreign oil, this trend will continue in years to come.

Another place where Americans are feeling it is at the local Stop 'N Shop. In fact, some believe that the rise in food costs could have a more devastating effect on consumer confidence than gas prices. On average, Americans spend three times as much for food as for gasoline. Imagine a typical 4-person household consuming 3 gallons of milk per week. The estimated 26% increase this year in milk prices translates to an extra $3 out of American's bank accounts. And this is only one commodity. Expand that to an entire grocery list and the impact is severe. Higher food costs cut into discretionary income which buys everything from cars to laptops and drives the US economy.

The primary role of the Fed is to combat the above-mentioned issues and to maintain consumer and investor confidence in the Fed's ability to control inflation. This would mean that the Fed is more likely to raise rates if it suspects inflation, even if that risks recession. If I were acting as one of the Governors of the Federal Reserve and sitting on the Federal Open Market Committee (FOMC), I would argue the following to Ben Bernanke, "hike the Federal Funds rate by 100bps." A 75bps increase would be helpful but 100bps would send a clear message of the need to strengthen the dollar. In the announcement following the rate hike I would recommend to stress the following points:

1. Even though many feel the economy is unsalvageable, we are not in a recession

2. Employment