As expected, the U.S. Federal Reserve Board last week decided to keep short-term interest rates at a 46-year low. Concerns about the fragility of the U.S. economic recovery prevailed over fears of a new bout of inflation. But the Fed signaled its readiness to raise interest rates soon if prices appear ready to increase. That balancing act is complicated by the upcoming U.S. presidential election and instability in the Middle East, which is forcing oil prices to record heights. The Fed move creates dilemmas for American trading partners. The world needs a strong and dynamic U.S. economy, which props up international demand as a consumer of last resort. Higher interest rates could slow that engine. But higher interest rates will also strengthen the U.S. dollar, making other countries' products -- including those from Japan -- more competitive.
U.S. short-term interest rates are now at 1 percent, the lowest level in over four decades. At that level, banks can lend money to their customers at about 4 percent, which makes it easier for consumers to borrow and spend. The Fed set that rate last June as the U.S. economy was struggling to regain its feet after a punishing recession. For some time, the Fed has also worried about deflation. As Japan well knows, falling prices might be a short-term boon to consumers, but continually falling prices make a recovery problematic by making it harder for producers with falling sales revenue to pay for inventories or to pay off debts.
In recent months, fears of deflation have eased. Federal Reserve Board Chairman Alan Greenspan told Congress last month that "threats of deflation, which were a significant concern last year, by all indications, are no longer an issue for us." In its statement released after last week's meeting, the Fed noted that the U.S. economy is "continuing to expand at a solid rate and hiring appears to have picked up." The economy grew at a 4.2 percent annual rate in the first quarter of this year, up from 4.1 percent in the fourth quarter of 2003. Some economists expect 4.5 to 5 percent growth in the April-to-June quarter.