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Why the Fed needs to boost risk tolerance

The drop in stock prices last month had some people wondering whether it was time for Alan Greenspan and the Federal Reserve to call a halt to raising interest rates.

That might come as a shock to many other market observers. The federal funds rate is at just 2.75%; at the start of the year some predictions had it that it would go as high as 4.5% by the end of 2005. And for now the Fed is maintaining its stance of measured increases, which is its way of telling market participants that they should expect quarter-point increases at each successive open market committee meeting.

Those in favour of putting a halt to rate increases argue that these are starting to have an adverse effect on growth, even at such low long-term levels. The regular increases, they argue, are draining liquidity from the system.

They are meant to, of course, especially from some of the more speculative trades hedge funds, prop desks and closed-end funds had jumped into while rates were falling. It's one of the reasons the Federal Reserve brought in the measured response, precisely to make sure the speculative financial markets of 2002 to 2004 did not crash.

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