“As the Federal Reserve prepares to meet about interest rates on Tuesday, recent fears about price deflation have in large part abated,” writes Edmund Andrews in today’s New York Times.

“Three months after the Fed began hinting about its readiness to nip any trend toward declining prices before it started, even if it meant reducing short-term interest rates almost to zero, officials have made it clear they are now less worried than they were before and more reluctant to jump in with unconventional tactics.”

“Many financial analysts, some taking their cue from the Fed, have shifted their outlook as well. Suddenly there is more talk about faster growth and rising prices for many commodities.”

” ‘A few months ago, fears of deflation were extraordinary and in my opinion overdone,’ said Kermit L. Schoenholtz, chief economist at Citigroup Global Markets. ‘Now the markets are going in the opposite direction, and I think some of that is overdone as well.’ “

“Almost all analysts predict that the Federal Open Market Committee will leave the federal funds rate on overnight loans between banks unchanged at 1 percent.”

“The Fed may also express slightly greater optimism than it did after its meeting in June, when it reiterated its worry about ‘an unwelcome substantial fall in inflation’ and described economic prospects as ‘weighted toward weakness.’ “

“But Fed officials have made it clear they are less worried now about deflation than they were just a few months ago. Alan Greenspan, the Fed chairman, told a Congressional hearing last month that he did not think it would be necessary to fight deflation with unconventional tactics like buying up longer-term Treasury notes.”

“Buying longer-term securities, rather than simply setting the federal funds rate, would allow the Fed to pump more money into the economy even if the overnight lending rates had dropped to zero, as they have in Japan.”

“Fed officials say they are still prepared to take such measures, but they say the conditions have improved and that such measures are unnecessary for the moment. They also insist that Mr. Greenspan has never really changed his views, because both he and other officials were always careful to say they viewed the likelihood of deflation as remote.”

“But has the risk of a Japanese-style downward price spiral actually diminished?”

“Optimists note that a variety of recent data indicates that economic growth in the United States accelerated to 2.4 percent at an annual rate in the second quarter. And while nearly half of the economy’s growth came from increased government spending, business investment also increased sharply.”

http://www.nytimes.com/2003/08/12/business/12FED.html