(May 15) – If the U.S. Federal Reserve Board raises interest rates by a full half-point tomorrow, as it’s widely expected to do, this will represent a significant change in its policy, writes Peter Cook in today’s Globe and Mail Report on Business.

The Federal has raised rates five times since last June. “This activity has in turn been transmitted to the bond, stock and currency markets, which in response have gone through turbulent times,” says Cook.

“Unbelievably turbulent times, as it turns out. Because it is measured objectively by what it is attempting to do — slow a runaway U.S. economy that is bound to generate inflation — the Fed ain’t done nothing yet.

“This week, the policy that the Fed has pursued in the third term of its much-praised chairman, Alan Greenspan, of acting late and undershooting, is set to change. Or so the popular wisdom in this town has it.

“When its Open Market Committee meets Tuesday, the Fed is likely to okay the first half-percentage-point rise in a long time (under Mr. Greenspan, the norm has been a rise of 0.25%). By doing this, it will acknowledge that it is no longer ahead of the U.S. inflation curve but behind it, and that similar large rate hikes may be needed in the balance of the year. Tacitly, it will also acknowledge that a policy of proceeding with cat-like tread so as not to upset Wall Street has not worked. Investors have been treated to 250-point daily swings in the Dow Jones industrials anyway. Get tougher, make more noise and — who knows — they may even be reassured.

“Inevitably, a determined bid to slow the economy will mean that investors’ expectations of future growth and profits will take a big hit. And just as inevitably — since those expectations are so inflated — there could be a market crash, leading to a sharp downturn in consumer demand and a far worse outcome for the economy than the Fed actually wants. But this is a risk that now has to be taken since there are no alternatives left.”

Despite the remarkable performance of the U.S. economy over the past decade, and
“for all the talk of the New Economy, the older immutable laws governing inflation have not been repealed,” Cook notes. “Run an economy too fast for too long at above its potential rate of growth, and bottlenecks and supply problems start to show up in labour and product markets. And this in turn causes prices to rise …

“To date, the Fed has opted for modest interest rate rises, hoping they will slow the economy. They haven’t. The economy is growing even faster. Now the Fed must get serious,” he concludes.