WASHINGTON -- The recent upturn in interest rates is threatening to slow the current economic expansion and is hurting municipal bond issuers, the congressional Joint Economic Committee said in its annual report issued yesterday.

"The sharp increase in interest rates has rattled the municipal bond market, creating problems for state and local governments," the JEC report says.

The report, whose main conclusions are written by Democrats in the House and Senate, says that the Federal Reserve's moves to tighten monetary policy have been accompanied by an unexpectedly sharp rise in long-term interest rates.

Bond market rates have also taken a pounding from speculation in hedge funds and the widespread use of leverage, the report says.

The report's authors say that given expectations that the federal budget will remain tight over the next few years, the Federal Reserve retains "a particularly important role" in keeping the economy going.

However, the report says the Fed has failed to provide a public rationale for why it is raising short-term rates. While stable inflation "yields real results," it adds, "at the current juncture, the challenge is to encourage economic growth."

The report also faults the idea often voiced by Fed policymakers of seeking to lower inflation. With current rates of inflation "still very low, achieving still lower inflation measured on some mechanical index seems unlikely to yield noticeable gains," it says, and "may be a serious mistake" because of the potential for lost jobs and output.

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