Certainly, this won?t be the Fed?s last move in this recovery cycle. With the 2-year Treasury now around 2.46 percent, the 3-month T-bill rate could be near 2.5 percent by August 2006. But this would be a tame and cyclical interest-rate rise; one that is much more benign than the current consensus of economic forecasters would have us believe.
A tame Fed would match up perfectly with this turn in the inflation tide. In view of the apparent shift back to core price stability this spring and summer, the central bank has plenty of room for a multi-month pause after it raises rates later this month.
With productivity trending around 3 percent over the past ten years and average labor-force growth running around 1.2 percent annually, the U.S. economy?s potential to grow is now about 4.25 percent yearly. Unemployment will decline if this growth rate is maintained. Surely the Fed would not wish to interfere with this outcome by pursuing fictitious inflation with interest-rate overkill.
A 4.25 percent real economic growth rate is about 1.5 percentage points faster than long-run Congressional Budget Office estimates. What those green eyeshades at the CBO fail to understand is that higher productivity rates bolstered by lower tax rates on capital formation will grow the economic pie larger and create a flood of new tax revenues at lower tax rates. As surplus revenues fill-in the budget gap, budget surpluses, rather than gloomy deficit projections, could reappear by 2011.
Of course, all of this is provided the Fed keeps its paws clean and Congress holds tax rates down.