From the Economist: Monetary policy / Desperate measures

[Guy Berger]

Monetary policy

Desperate measures

Jan 22nd 2008

From Economist.com

A whiff of panic as the Fed cuts rates

AFP

THE Federal Reserve slashed its benchmark interest rate by three-quarters of a percentage point to 3.5% on Tuesday January 22nd. The decision came at an unscheduled policy meeting—the next planned one was due on January 29th and 30th, when it was widely expected to reduce rates by half a percentage point. With global stockmarkets in freefall, the Fed instead decided that a bigger cut was needed—and sooner. A week may be a long time in politics, but waiting eight days to cut rates would, it seems, have been an intolerable stretch for financial markets.

The deepening gloom about the economy may well warrant such an aggressive response. But the timing is puzzling. There is more than a whiff of panic about slashing rates little more than week before a scheduled meeting. The Fed statement issued with the decision rationalises the cut as a response to "downside risks to growth"—the phrase is repeated twice in six short paragraphs—and cites recent gloomy data on housing and jobs. Yet the economic news has not grown any worse in the past few days and, given the time needed before monetary policy affects spending, the added urgency seems odd.

What has shifted for the worse is financial-market sentiment. It is hard not to conclude that the Fed has acted to shore up markets, which have switched to panic mode alarmingly quickly over the past week. The Fed noted—it could hardly fail to do so—that "financial market conditions have continued to deteriorate". But if concerns of further stockmarket damage was its main motivation the cut did little to prevent a big sell-off on Wall Street. The Dow Jones Industrial Average fell over 400 points when it opened shortly after the Fed's announcement: not much less than the fall that was priced in before the Fed acted.

If the markets failed to view looser monetary policy as a nice surprise, that was understandable. In his short tenure the Fed's chairman, Ben Bernanke, has only used scheduled meetings to make changes to the Fed's main policy rate. That he was moved to act just a week before one will raise the suspicion that the Fed knows something that markets don't. Nor is it only the timing that is troubling. The size of the cut also brings more fear than comfort. Even the Fed under Alan Greenspan, which cut rates from 6.5% to 1% in the early years of the decade, was never moved to cut by more than half a percentage point in a single go.

Only one voice dissented on the Fed's rate-setting committee. William Poole voted against the cut, arguing that things were not sufficiently bad to warrant action so close to a regular meeting. That no one else was swayed by that argument suggests that the bulk of the committee is now either very worried about the economic outlook or that there was a serious risk of financial-market meltdown. Concerns about inflation, which the Fed expects to moderate, have been relegated almost to an afterthought.

The meeting at the end of the month is still expected to go ahead and it seems unlikely that the Fed's committee will convene only to sit on its hands. Futures markets are pricing in a further quarter-point cut on January 30th. Presumably the markets can manage to hold on until then.

[connoisseur series500]

Based on today's market movements, the gloom of this article seems rather stretched. Time will tell, but Bernacke's move might prove to be brilliant. Market sentiment and psychology is important to our economy.

[Jazzmoose]

It looks like panic to me as well. Still, it's nice to see a change in economic reporting; apparently no one is worried about a freefalling dollar anymore...

[Chas]

Based on today's market movements, the gloom of this article seems rather stretched. Time will tell, but Bernacke's move might prove to be brilliant. Market sentiment and psychology is important to our economy.

I couldn't disagree more .

The Fed is taking their customary hair-of-the-dog approach : an economy drunk on cheap money needs...........more cheap money ! The Fed's move was acknowledgment , if any was needed , that the U.S. economy and the consumption which drives it , are now structurally dependent on unbounded credit expansion and concomitantly rising asset values. In such a debt-saturated society inflation is tacitly welcomed while deflation is openly fought . Given that the business cycle is a function of an unchanging human nature , attempts to abolish it are misguided , and what's more , are downright dangerous . Forest rangers know that if occasional small fires are always extinguished , the risk of a forest-destroying conflagration grow enormously . Likewise , small tremors relieve some of the pressures that cause devastating earthquakes . The economy is like this too . The Fed is in effect trading the current economic pain of the few for the future economic pain of the many . That the Wall Street tail now wags the economic dog is reason aplenty for gloom .

[The Magnificent Goldberg]

Based on today's market movements, the gloom of this article seems rather stretched. Time will tell, but Bernacke's move might prove to be brilliant. Market sentiment and psychology is important to our economy.

I couldn't disagree more .

The Fed is taking their customary hair-of-the-dog approach : an economy drunk on cheap money needs...........more cheap money ! The Fed's move was acknowledgment , if any was needed , that the U.S. economy and the consumption which drives it , are now structurally dependent on unbounded credit expansion and concomitantly rising asset values. In such a debt-saturated society inflation is tacitly welcomed while deflation is openly fought . Given that the business cycle is a function of an unchanging human nature , attempts to abolish it are misguided , and what's more , are downright dangerous . Forest rangers know that if occasional small fires are always extinguished , the risk of a forest-destroying conflagration grow enormously . Likewise , small tremors relieve some of the pressures that cause devastating earthquakes . The economy is like this too . The Fed is in effect trading the current economic pain of the few for the future economic pain of the many . That the Wall Street tail now wags the economic dog is reason aplenty for gloom .

I'm very inclined to agree with you, though I've never been clearly convinced that there is such a thing as a business cycle that operates, so to speak, independently of policy, as if it were the waves of the ocean that Canute couldn't turn back.

I also love the Credit Crunch Cereal pic. Is it a coincidence that the guy in that pic looks (to me, anyway) like the guy at the head of the Economist article? Is this Bernanke?

MG

[Chas]

I also love the Credit Crunch Cereal pic. Is it a coincidence that the guy in that pic looks (to me, anyway) like the guy at the head of the Economist article? Is this Bernanke?

Yes that is the great and powerful Oz er, Federal Reserve Chairman Ben Bernanke .

[The Magnificent Goldberg]

I also love the Credit Crunch Cereal pic. Is it a coincidence that the guy in that pic looks (to me, anyway) like the guy at the head of the Economist article? Is this Bernanke?

Yes that is the great and powerful Oz er, Federal Reserve Chairman Ben Bernanke .

Thanks Chas. I wondered if it was C W Gilbertson, whoever he is.

MG

[Guy Berger]

Based on today's market movements, the gloom of this article seems rather stretched. Time will tell, but Bernacke's move might prove to be brilliant. Market sentiment and psychology is important to our economy.

I couldn't disagree more .

The Fed is taking their customary hair-of-the-dog approach : an economy drunk on cheap money needs...........more cheap money ! The Fed's move was acknowledgment , if any was needed , that the U.S. economy and the consumption which drives it , are now structurally dependent on unbounded credit expansion and concomitantly rising asset values. In such a debt-saturated society inflation is tacitly welcomed while deflation is openly fought . Given that the business cycle is a function of an unchanging human nature , attempts to abolish it are misguided , and what's more , are downright dangerous . Forest rangers know that if occasional small fires are always extinguished , the risk of a forest-destroying conflagration grow enormously . Likewise , small tremors relieve some of the pressures that cause devastating earthquakes . The economy is like this too . The Fed is in effect trading the current economic pain of the few for the future economic pain of the many . That the Wall Street tail now wags the economic dog is reason aplenty for gloom .

I disagree. Recessions are usually miserable -- particularly ones that last a long time -- and usually don't cause pain for "the few". Just because the business cycle is an inevitable part of most economies doesn't mean that governments and central banks shouldn't attempt to soften its sharper edges.

That said, I agree that the Fed's apparent response to a prospective sharp fall in the stock market sets a bad precedent and one that will cause them pain in the future.

Guy

[The Magnificent Goldberg]

I disagree. Recessions are usually miserable -- particularly ones that last a long time -- and usually don't cause pain for "the few". Just because the business cycle is an inevitable part of most economies doesn't mean that governments and central banks shouldn't attempt to soften its sharper edges.

If the business cycle is an inevitable part of most economies, it isn't inevitable, yes?

Softening the sharper edges of a recession is a worthwhile endeavour; however it's one which usually turns out to make things worse in some unforseen way. That's because everyone's problem is some other bugger's opportunity.

MG

[Guy Berger]

I disagree. Recessions are usually miserable -- particularly ones that last a long time -- and usually don't cause pain for "the few". Just because the business cycle is an inevitable part of most economies doesn't mean that governments and central banks shouldn't attempt to soften its sharper edges.

If the business cycle is an inevitable part of most economies, it isn't inevitable, yes?

Softening the sharper edges of a recession is a worthwhile endeavour; however it's one which usually turns out to make things worse in some unforseen way. That's because everyone's problem is some other bugger's opportunity.

MG

Hence Milton Friedman's recommendation to replace the Fed with a DeskJet that prints out money at a constant rate.

I agree that the Fed should avoid trying to fine-tune the economy -- but also think that when the economy is slipping toward recession there is scope for well-executed monetary policy (and well-executed fiscal policy, if such a beast is possible) to mitigate the pain.

Guy

[The Magnificent Goldberg]

Does the present administration specialise in "well-executed" policies then?

MG

[Guy Berger]

Does the present administration specialise in "well-executed" policies then?

MG

Assuming you are talking about fiscal policy -- that's a question that should probably be left for the politics forum.

Edited January 26, 2008 by Guy

[The Magnificent Goldberg]

Does the present administration specialise in "well-executed" policies then?

MG

Assuming you are talking about fiscal policy -- that's a question that should probably be left for the politics forum.

MG