NCPA - National Center for Policy Analysis


April 20, 2005

Last week's meltdown in the stock market, with major indexes falling three percent, is only the latest indication that the economy is in fragile condition. One is even starting to hear the first whispers of the "R" word (recession). Although such expectations are premature, the financial sector of the economy is under growing strain that could burst and spill over into the real economy suddenly and without warning, says Bruce Bartlett, a senior fellow with the National Center for Policy Analysis.

The basic problem, says Bartlett, is a simple one: the Federal Reserve is tightening monetary policy.

  • Historically, this has preceded every major economic slowdown or significant market correction.
  • For example, the Fed began tightening in mid-1999, the stock market peaked in early 2000, and clear signs of a recession were evident by the fall of 2000.

The Fed's current cycle of tightening began in June 2004, so it is not surprising that we are starting to see the first signs of an impact, says Bartlett.

  • Since then, the Fed has almost tripled the federal funds interest rate from one percent to 2.75 percent.
  • Moreover, there is every reason to believe that the Fed will continue tightening for the foreseeable future.

The reason is that the Fed is concerned about the reemergence of inflation. All the early warning signs of this are in evidence: the dollar has been weak on foreign exchange markets, commodities like oil are rising rapidly, housing prices continue to go up at an amazing rate, and the growth of productivity has fallen significantly. Although these factors have yet to seriously impact on consumers, except for the skyrocketing price of gasoline, it is only a matter of time before these fundamental inflationary forces work their way through the system and start raising the Consumer Price Index, says Bartlett.

Source: Bruce Bartlett, "Steering Clear of Recession," National Center for Policy Analysis, April 20, 2005.


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