Katrina and the Fed

THE FEDERAL RESERVE responded to Hurricane Katrina on Tuesday by ignoring it. Though that may sound harsh, the Fed’s reaction was the most helpful policy it could have chosen.

As the rest of Washington scrambles to come up with Katrina policy proposals -- or, more accurately, strains to find a Katrina rationale for existing policy proposals -- the Fed continued its steady march against inflation, raising its benchmark short-term interest rate for the 11th time in the last 15 months. It is now 3.75%, up from 1% in June 2004.

The purpose of increasing interest rates, Chairman Alan Greenspan has said repeatedly, is to prevent inflation. (Greenspan is constitutionally unable to use clear language, however, so he prefers to say that the Fed will “continue to remove monetary accommodation.”) In reaction to the Fed’s move, most banks raised interest rates on short-term loans to consumers and businesses.

In the aftermath of Katrina, some economists had expected the Fed to take a breather. Higher interest rates can keep inflation low (by reducing the money supply), but they can also retard economic growth (see previous parenthetical). Katrina disrupted several major industries, including energy, agriculture and transportation, and caused widespread job loss and dislocation. Some economists worry that the economy will slow because of it.

But in the statement that accompanied its announcement of the rate increase, the Fed essentially told the nation not to be too concerned about all that. Instead, in an oddly reassuring expression of anxiety, it said that the storm could result in “higher energy and other costs” that could “add to inflationary pressures.” In other words: Katrina didn’t change everything. We’re still mainly worried about inflation.

Of course, the statement went on to say, as such statements almost always do, that the Fed wasn’t too worried -- no need to get people all jittery. And it even included a mention of the “tragic toll” of Katrina -- unusual language for a monetary policy statement. It also noted that the Fed would continue to raise rates at a “measured” pace.

The Fed’s view of the economy is by no means undisputed, and Greenspan is by no means immune to politics. So its reasons, and his motivations, are always open to debate. But by not changing its policy, the Fed has delivered a message that the economic consequences of Katrina may not be as devastating as many Americans had feared.