Tuesday, March 18, 2008

A policy puzzler

The Fed is so screwed. Economic growth has slowed to a crawl at best, housing prices are taking forever to adjust down after the bubble, credit markets are panicky like Mungowitz when there is only one six pack left in the fridge, and inflation is on the rise.

Now it seems clear, given that markets are expecting a 3/4 to 1 percentage point cut in the Fed Funds rate later today, that the consensus opinion is that the Fed is committed fighting recession and ignoring inflation risks.

On the one hand, this makes sense because a recession is probably more painful than some extra inflation (which presumably the Fed would slowly bring down after the crisis has passed). On the other hand though, it doesn't make sense because the Fed can actually control inflation and its main policy tool, the rate cut, stands little chance of averting a recession especially compared to its chances for further aggravating inflation.

Now Mrs. Angus and I both have tenure (and university enrollments are still booming for the time being) and we are planning a foreign vacation this summer, so maybe my views are totally skewed by my own self-interest here, but I think the Fed is making a mistake. They can pursue their lender of last resort function (which I think is good policy given our credit market panic) without also pursuing their panderer of first resort path of continuing to cut the funds rate.

People, we had a huge asset bubble burst and the asset in question (housing) has slow price adjustment. Cutting the Funds rate won't change this.


Anonymous said...

Unquestionably the Federal Reserve faces a difficult challenge right now. However, isn't it possible that incredibly loose monetary policy under Greenspan has contributed to the current crisis and potentially eroded the credibility of the Fed? When did it become the Fed's mission to utilize incredibly lax monetary policy (in a potentially unprecedented fashion) to potentially avoid a minor recession? In fact, have we come to believe that a recession, no matter how minor, is to be avoided at all costs? Have we come to believe that there really is no such thing as "creative destruction" and that a recession could potentially have cleansing effects? Further, doesn't it seem as though the potential exists for loose monetary policy to only delay an inevitable downturn, that potentially increases in severity as the Federal Reserve continues to erode the value of the US dollar, not just financially, but potentially psychologically as well? With unemployment at 5% and wholesale price inflation creeping near 12% last month, it just seems to me that this unprecedented expansionary policy is unwarranted and potentially dangerous.

Angus said...

"However, isn't it possible that incredibly loose monetary policy under Greenspan has contributed to the current crisis and potentially eroded the credibility of the Fed?"

possible, probable, likely. Greenspan screwed up bad, IMO.

Anonymous said...

Brother Sooner,
I don't know if them scalliwags have cleaned out them there pop econ hills, but if there's an ingot or two left, you oughta supplement that tenure money with a tome of your own-- making sure to bring the herd of LOL catz up the trail (and onto the cover) with you.
Failure to do so would be sinful beyond anything Greenspan devised.