The Post reported on the release of the minutes of the last meeting of the Federal Reserve Board's Open Market Committee at which they decided to lower interest rates by one quarter of a percentage point. It notes their concern with the prospect of higher inflation but indicates that this would only come from higher oil prices about which they can do little. Actually, a second important potential source of inflation is higher import prices, which is at least in part attributable to a falling dollar. Non-fuel import prices rose at a 3.6 percent annual rate over the last quarter and may rise even more rapidly in the future as more importers pass on currency related price increased. With non-fuel imports comprising almost 15 percent of GDP, a 2.0 percentage point increase in the inflation rate in this sector would translate into a 0.3 percentage point rise in the overall rate of inflation. With inflation already at or above the Fed's targets, this sort of increase in the inflation rate could concern them. Also, higher interest rates can be an effective tool for maintaining the value of the dollar and thereby stemming the inflationary pressure from higher import prices. Of course the cost of keeping interest rates high to support the dollar would be lower growth and higher unemployment.
--Dean Baker addendum -- (courtesy of a careful reader) The Fed is concerned about inflation from import prices: "Moreover, earlier increases in energy and food prices likely would imply higher headline inflation in the next few months, and past declines in the dollar would put upward pressure on import prices."
