The Federal Reserve Board usually agonizes over whether to cut interest rates. But last week's decision was made a little easier by an experimental forecasting model called P-Star.
The model, developed in 1989 at the urging of Fed Chairman Alan Greenspan, measures long-term inflationary expectations.
Its latest predictions show a discernible trend toward lower inflation - in the 2% range - over the next one to two years.
That, no doubt, gave Mr. Greenspan and his colleagues comfort that a half-point cut in the discount rate would not set off inflationary pressures.
Indeed, in its announcement Thursday, the Fed cited a "continued movement toward price stability" as one of the factors behind the rate cut.
The model compares two indicators of inflation:
* The gross national product price deflator, which measures the rte of inflation across the economy, and
* P-Star, which takes into account the velocity of the money supply as well as the GNP adjusted for inflation.
Under the theory, if P-Star falls below the GNP deflator, as it has for more than three years, inflation will decline in the future.
This year, consumer prices have grown at an annualized rate of little more than 3%. Producer prices, which presage consumer prices, are growing at 2.4%. The P-Star model indicates that price pressures will decelerate further. (P-Star is economists' shorthand: "P" stands for "price levels"; "Star" - which is realty an asterisk - denotes long-run value.)
Comfort for Policymakers
To be sure, P-Star is only one of many inflation indicators that Fed policymakers look at. And, in light of the dismal unemployment report issued Thursday, the Fed may have cut rates regardless of what P-Star indicated.
Still, the model is giving monetary policymakers added assurance as they cut rates in the face of evidence that the recovery is idling.
"If Greenspan saw P-Star predicting something higher than 3% or 4% inflation, he might not have been as willing to ease," said Edmond J. Seifried, chairman of the economics and business department, Lafayette College, Easton, Pa.
