FOMC: ‘Which Way Do We Go?’
Several readers suggested a topic about the Fed rate decision this coming week. “I think that the most important driver is the Federal Reserve. There’s pressure to raise a quarter given what has happened with other central bankers this week. And there is pressure to pause due to pressure on ARM folks. Which way do we go? As a saver, I’d prefer a hike.”
A reply, “One more interest rate raise of 25bps on August 8th. Also, a statement basically saying that a pause is coming at the next meeting.”
And another, “Since I believe that a recession is nigh unavoidable, I’d rather see them fight inflation. Of course the market prediction has been ‘one more quarter point, they they’re done’ for the past 6 meetings or so.”
One said, “Track record of the FED is to put off the day of reckoning for another time. I’d like to see a couple more rate hikes, but believe that they are finished for the time being.”
One agreed, “Unfortunately, I am of the same opinion. I believe Paulsons comments earlier this week about a ’strong dollar’ have evaporated. China believes that it is now able to float the Yuan without impacting its export economy.”
“‘So much manufacturing capacity has moved to China that foreign-owned firms now account for 51 percent of China’s trade surplus, up from 3 percent in 2000, according to Lehman Brothers.’ Trade surplus may defy orthodox currency cure.”
The Washington Post. “Federal Reserve policy-makers haven’t provided a wink, a nod or even a coded phrase to telegraph what they plan to do with interest rates when they gather Tuesday, the first time in three years the outcome has been uncertain so close to their meeting.”
“The reason, analysts say, is simple: Fed members themselves don’t know, with some pressing for the 18th consecutive increase in interest rates and others ready for a break.”
“Bernanke used his most recent public appearance (to) outline the collective goal of the policy-making Federal Open Market Committee: a so-called soft landing in which the economy slows down just enough to tame inflation without sliding into recession.”
“And he said the forecast represents what the policy-makers expect to happen if they adjust interest rates just right, without saying specifically how they will do so. This approach is called ‘inflation forecast targeting’ by Fed economists and academics.”
“Now, Fed policy-makers are divided about what to do. They do not know if the housing market slowdown is going to continue to be ‘orderly,’ as Bernanke has described it, or worsen sharply.”
“With the economy losing steam and inflation accelerating, the Fed does not want to raise rates too much and tip the economy into recession, or raise rates too timidly and let inflation get out of control. ‘If you don’t know which way you’re going, it’s hard to send up a flare,’ said former Fed vice chairman Alan S. Blinder. ‘This is pretty close to a 50-50 call.’”
Rates up, home prices down!
I think the fed is in a jam. Their rates are still at a low point from a historical perspective, but already the economy is looking green around the gills. Worse yet, the stagflation beast is stirring, and it seems the bond market has its own ideas about what the real rates should be.
Does the fed give up and spare the rod, or do they snap the reigns and try to reel it in? How important is it that they establish the perception of control in the broader world market?
My guess is (as stated elsewhere) that they press for 25 BP more up this time, and they don’t give any additional guidance going forward. I am sure I am projecting my own ideas into this (not a finance guru) but I would hope that they are going to keep the dollar competitive in an era when the market is increasing the cost of money.
Or maybe it’s out of their hands. From Australia:
‘Yesterday’s 25 point rise in the official interest rate will add $49 a month to an average $300,000 home loan. John Howard, who had argued last week that inflation was under control, yesterday changed tack. ‘Nobody likes interest rates going up, but I don’t believe that the Reserve Bank had any responsible alternative other than to take that decision,’ he said.’
Rates up, regardless of what the Fed does. Home prices down.
Does it really matter? Honestly, it doesn’t make any difference what happens with rates now, the housing industry is-going in the tank regardless of what the FED does. The FED reacts, it does not create. period.
“…the housing industry is-going in the tank regardless of what the FED does.”
Probably true, but it’s like walking your dog on a really hot day: “C’mon boy, let’s get on with this.”
With my dog it was the rainy day that was the problem. She would just look at me while we were both getting wet and I’d say “Hey, the faster you go the sooner we both go back inside!!” …..
Re: fed action - for me, if they raise 25bps and take a pause, it means they are raising 25bps and taking a pause. They’ve been doing the micro raise thing for awhile, why not pause? Seems like a reasonable thing to do. Now as far as perception goes, well that is another story. People have to read something into everything. Maybe they will look for how many ‘r’s are in the accompanying statement to see if a recession is hidden in there somewhere.
And Paul McCartney is the dead beatle, remember? Play the speech minutes (record) backwards. Now there will be some great analysis!
I actually have a metric and when there are 48 or more ‘r’s in a statement there has always been a hike. However, only when there are more than 57 ‘r’s has there been a recession associated with the rate hike. This was associated with 17 ‘q’s, the statement being issued on a Tuesday, and a particularly aggresive bowel movement on my part.
I need more data, but I’m VERY CLOSE to having an exact answer for everyone. Just as a heads up, the Fed is going to raise by either 2,643 basic pts, or lower by 1,432 basis pts. There is also a 0.03% chance that Ben Bernanke will come to my house and sing Gilbert and Sullivan’s “Buttercup” while wearing a Tutu. Yes, this is not a particularly large number, but I try not to discount anything that may be relevant. I do have some investment strategies leaning directly towards this possibility, I’m sorry I can’t divulge them or it would disrupt their return. Suffice it to say they involve large amounts of tequila and small but vital amounts of powdered Rhinoceros horn. Yes, see, I can tell by your expression that you understand completely.
You may not believe me, but really, the numbers never lie.
I agree. It does not matter if rates go up or down when the economy is headed toward recession and/or inflation. Fed. rates has some influence but not absolut influence on economy. Economic imbalances are so desperate that rate change would do much at this point.
All the stars are lined up for a good recession. May be that is what this over-indulge, consuming obsessed society needs.
Really, Ben B/Fed reminds me of Kofi A/UN
Go to lunch, wear nice suit, make a resolution/raise or lower rates…
Doesn’t do much good one way or another in this world…they are truly reactionary.
I like Pater Schiff’s take on it either way economy is bust.
THE PAUSE THAT WILL NOT REFRESH
http://www.financialsense.com/fsu/editorials/schiff/2006/0804.html
I probably should have put my “Bank of Italy dumps dollar” post on this thread. It confirms Mr Schiff’s view.
Wow, if the Bank of Italy dumps the dollar, then something is seriously wrong! Italy is like the biggest basket case of the G7!!!
Or was…
I like Peter Schiff’s take on it either way economy is bust.
THE PAUSE THAT WILL NOT REFRESH
http://www.financialsense.com/fsu/editorials/schiff/2006/0804.html
If Peter Schiff is right, long term rates would rise if the Fed pauses. However, Bill Gross, while agreeing that the Fed will pause, argues that long bonds will do well on a pause. That’s the real debate: what happens to long rates?
I loved this paragraph from Schiff’s piece:
“A surge in long-term rates will immediately translate into higher mortgage rates, putting the final nail in real estate’s coffin. The bubble is finally dead, may it rest in peace. Unfortunately the same can not be said for those who bought into it, and those who financed the speculation. For them, and the entire nation for that matter, the real estate nightmare is just about to begin.”
The Night of the Living Flopper. Coming soon to a theater near you.
Bill Gross puts a few tens of billions on the line behind his forecasts. He could be wrong of course, but he has the analytical skill and data to support his case.
By the way, his case is that this will be the “last” bull market in bonds for a very very long time, and after the short term cyclical phenomenon, bonds and the dollar will then really go down.
The fact that he states emphatically that we see one more high followed by continues low belies skill on his part.
How can anyone who has prognosticated for more than a couple quarters state anything like it? I’m sure he is a smart man, but sounds misguided at this point.
I agree with his long term direction, but I wsa sure of the same in ‘03 and to be frank, lost a pretty penny on it.
New York Times courtesy of a reader and the TImes’ weblog link generator:
‘The most volatile part of the American economy has slowed significantly in the last nine months, providing a warning of both recession and lower stock prices. The measure looks at growth in three broad areas that are the most sensitive to economic changes and to interest rates; consumer purchases of durable goods, residential construction spending and business investment in equipment and computer software. They can be called the sensitive sector.’
‘This is only the ninth such reversal since 1954. Each of the previous eight foreshadowed a substantial slowing of the overall economy, although not all were quickly followed by recessions. There was no early recession after reversals in 1955, 1964, 1978 or 1987. But recessions followed quickly after reversals in 1959, 1969, 1973 and 2000.’
Geez, how many more recession indicators can be in play here? If GDP doesn’t go negative by the end of 2007, it will be an economic miracle.
Bank of Italy dumps dollar
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2006/08/03/cnboi03.xml
“An Italian official said the Banca d’Italia was taking action in advance of a dollar slide, widely expected as the US interest rate cycle peaks this summer and investors focus once again on the US’s $800bn (£425bn) current account deficit.”
I picked up this discussion from the Piggington site. If the Fed pauses and central banks begin dumping US Treasuries, won’t yields go up?
Take a look at the ten year. Last I saw yesterday it was at 4.95. Flight to quality as market tanks?
Now that’s pathetic, when the Italians don’t want to hold Dollars!
However, the chart in that link shows that the dumping occurred between 2004 and 2005.
To answer your question, yes, yields will go up. My question is, what are dollar sellers buying besides sterling? Gold, and very quietly I imagine.
As a dollar seller I’d buy emerging market (asian, eastern european and latin american) bonds and gold. Maybe some ‘old’ europe bonds too. I’d under allocate sterling assets.
Then, after the inevitable correction I’d jump, big time, into emerging market stocks.
Emerging markets? Check out Bens’ metals blog for the story of Belize preparing to default on its debts. Ouch.
“To answer your question, yes, yields will go up. My question is, what are dollar sellers buying besides sterling? Gold, and very quietly I imagine.”
I don’t have proof, but I think very few Americans are buying gold these days. Lots of Indians, Chinese, and Middle Eastern people are buying gold though, but not enough to make a good runup in prices.
There were too different Infomercials this morning touting gold. To me, that’s a sign to get out of gold.:)
I think gold and most other commodities are all about timing, which is tough to get right. Just ask anyone who bought gold at the last top, back in the 80s.
“I think gold and most other commodities are all about timing, which is tough to get right. Just ask anyone who bought gold at the last top, back in the 80s”
When gold makes cover of Time magazine with the headline in the same theme of “time to buy?”, it is too high in price.
For those that haven’t seen $USD charts before, I posted one at
http://www.vector64.com/trading/USD20060804.png
The situation of the dollar looks precarious. The high for the $USD was around 121 or 122 several years ago and doesn’t show up on this charts as it only covers two years.
Why do interest rates matter? Well, this spring and summer
hasn’t been the kindest to most traders and investors and
you have some with money in the market, starting to look
at fixed income instruments as they are at the low end of
historical short-term rates and are becoming attractive.
If house prices are coming down, it makes sense to save
up more of a downpayment while housing comes down.
It also takes money out of the stock market which can
be used to purchase housing. A marginal increase in a
stock price generates a multiplier effect on wealth that
is used to buy real goods and products. If you have a
million shares outstanding on a stock and it goes up a
dollar, then you’ve created $999,999 with the addition
of a dollar. Of course it works in reverse as well.
The pundits on the radio shows this weekend are expecting
a pause and they provide good anecdotal reasons for a pause.
But a pause will be looked at as being inflationary (see
equities, gold, oil, natural gas if we pause). The Fed has been
tight with liquidity late this week, perhaps trying to prop
short-term paper to the target.
This realtor ™ commercial will go down in history as the scummiest of the scum. And perhaps the top of the bubble- just like those etrade ads where the truck driver was buying his own private island.
http://www.youtube.com/watch?v=Ubsd-tWYmZw
It’s the same tactic insurance salesmen use, when hawking a policy in front of your wife and daughter. “If you love your wife and daughter, you’ll buy this policy. You do love them, right? Hi little Sarah, what are you- 4 years old? I guess daddy doesn’t love you because he doesn’t want to buy this insurance policy from me.”
I’ve said it before and I’ll say it again: that commercial sickens me and gives me the creeps.
Your YouTube link has some great real estate commercials, now parodies.
Check out the US Dollar Index. Neat Java app over here:
http://www.fxstreet.com/rates-charts/usdollar-index/
The Fed is losing the battle to support the dollar. Look at the RSI line on that chart. Also play with the time scale for a longer view. Optimistically, the Dollar is trying to put in a bottom. Pessimistically, it could still go much farther down. From a chartist’s POV, the next support if it breaks lower would be at about 81-82.
So I think the Fed has to raise another 1/4 point just to hold their ground.
why do you think they want to support the dollar? a weaker dollar is good for exports and US companies doing business internationally.
all the strong dollar nonsense you read in the media never says what a strong dollar is, what level a strong dollar is, what level the dollar should be to be considered healthy and other things. all they say is the dollar was strong during clinton and is now weaker, but never say the reasons for it like the Euro was a new currency then. and the 2000 strong dollar played havoc with our exports and hurt US companies
A weak dollar means that China, India, Europe and Japan will more easily be able to outbid us for commodities like oil. A weaker dollar is nice for companies but one could argue that companies have done very well for the last couple of years.
If you want to look at the terminal stage of a currency collapse, look at Argentina a few years ago where the middle-class was destroyed.
Argentina was an unusual case because they had attempted to maintain a peg, and their previous government (Menem) was essentially corrupt and criminal. Argentina now is a great place for a tourist, and their domestic economy and exports are coming back.
Then again, they do make things that people want: raw materials and excellent food for cheap.
Why support the Dollar? Because it’s nearing the low end of its range right now. Zoom out to a longer view of the index. If it breaks down from here, all hell breaks loose. Oil prices could zoom past $100/bbl and gold could run up to $1000/oz in a matter of months. That would not be good for politicians hoping to get re-elected this fall.
What do I care for the gold price when I elect politicians? The higher price for oil is important, but it is like the high taxes on oil that most other countries in the world already charge on gas consumption.
As long as the sheeple don’t notice that the purchasing power of their dollar has been cut in half before the election, the pols are OK. But when a fill-up on your Hummer goes from $80 to $200, that will get the sheeple’s attention is a very dramatic manner, and woe be to the pols who don’t have a good story as to why it’s not their fault. In fact, woe be to any pol who can’t get out of the way the “throw the bums out” freight train that would result.
A weak dollar will result in inflation. Since wages can’t rise, Americans’ buying power will erode. Most (who have no savings) will therefore see a decreased quality of life.
Savings are not much help during inflationary times. They evaporate in the same way that lender assets do. Unless of course, the savings are invested in inflation hedges. Inflation pretty much sucks for everyone except debtors and those who are hedged.
“Inflation pretty much sucks for everyone except debtors…”
That’s good for the US government then.
And those with savings will probably watch them erode unless they are very smart and very lucky with their investments.
Our exports are miniscule compared to imports. A weak dollar will hurt more than it will help.
There is no way to have a strong dollar in the long run other than to export a lot of what the world wants. If the US can’t do that, and it looks like that the US can’t, then the standard of living in the US will decrease. Would that surprise you?
Great point. All that crappy Chinese stuff at Wallmart will get a lot more expensive in a USD meltdown, in addition to oil and a lot of other things. This assumes that we “win” the race towards the bottom with currency debasement and other countries don’t attempt to simultaneously trash their own currencies.
“All that crappy Chinese stuff at Wallmart will get a lot more expensive in a USD meltdown”
With all due respect DT, the crappy Walmart stuff is not what I worry about.
This is what bothers me: Toyota is poised to take over as #1 auto supplier in our country. Our telecommunications and internet hardware is manufactured where? And serviced where?
I was thinking the other day I might want to make that sewing machine purchase as imported clothes should soon skyrocket and I’ve got exponentially growing kidlets. (Damn…Shoulda married a short guy!
) Guess I’m stuck on the shoes.
And what always haunts me is who will be manufacturing our bombs, tanks, jets and communication systems during the next major war? Doesn’t sound like we’ve got enough engineers. We’re already shifting our high level code writing to India (as per Newsweek) So much for maintaining security.
The Federal Funds Futures market on the CBOT has priced in a 20% chance of a 25bpp increase, and an 80% chance of no change. Regardless of what anyone’s opinion is on this blog, the futures market has a great track record of predicting what the Fed will do….
Most predictive models fail at or around turning points. And I think you would agree that we are pretty much at a turning point here.
Not only that, but Greenspan’s predictable rate hikes did absolutely nothing to curb credit growth. It’s easy to model different credit structures when you know what the short term rates will be. Perhaps, on this go around, BB figured this out. If the Fed does indeed raise on Tuesday, my take is that the Fed had a good idea that they would, but finally decided to do something to keep the credit markets on their toes and perhaps throw into their modeling a degree of risk that’s been missing for the last 4-5 years.
Leaders
The Federal Reserve
The perils of pausing
Aug 3rd 2006
From The Economist print edition
America’s economy is slowing, but the Fed should still raise interest rates next week
WHEN Ben Bernanke succeeded Alan Greenspan as the chairman of America’s Federal Reserve earlier this year, The Economist’s cover illustration depicted Mr Greenspan as a relay runner, passing on a baton, in the form of a lighted stick of dynamite, to his successor. Mr Bernanke, this newspaper suggested, was inheriting an economy in much worse shape than popularly assumed (see article http://www.economist.com/opinion/displaystory.cfm?story_id=5385434 ).
Six months later, the fuse has burned low, with growth slowing and inflation on the rise. Output grew at an annual rate of just 2.5% in the second quarter of the year, well below capacity. And the speed with which the housing market is cooling suggests that a sharper slowdown may lie ahead. A growing number of commentators are now talking about a recession next year. At the same time, inflation is higher than America’s central bankers would like, and increasing. The price gauge that they watch most closely, the deflator for personal consumption expenditure excluding food and energy, went up by an annualised 2.9% between April and June, far above their preferred range of 1-2%. Well over half the components of the consumer-price index are rising at an annual rate above 3%.
This combination of strengthening inflation and flagging growth poses an awkward dilemma for Mr Bernanke and his colleagues, who next gather on August 8th. After raising short-term interest rates at 17 consecutive meetings, America’s central bankers have brought the federal funds rate to 5.25%. Monetary policy is no longer loose. By some measures it is a little restrictive. And since higher interest rates take several months to work their way through the economy, the impact of some of the Fed’s earlier actions is yet to be felt. If Mr Bernanke and his colleagues raise rates too far, they risk pushing a faltering economy into recession. But if they stop tightening policy too soon, inflation may get out of hand.
Thanks to the weak growth figures, financial markets are betting that the central bankers are more likely to stand pat next week than raise rates again. That would be a mistake. America’s economy may be losing steam, but the dangers of rising inflation outweigh those of slowing growth. If Mr Bernanke is prudent, he will increase rates once again.
For a start, the recent deceleration should not be exaggerated. Growth has indeed slowed abruptly, but from a blistering, unsustainable pace—5.6%, at an annualised rate, in the first three months of the year. Some of the second quarter’s weakness, especially in firms’ investment and in exports, may prove temporary. The rest of the world is still growing healthily. In the housing market, it is true, things are likely to get worse. Residential construction is falling, property prices are flat and the number of unsold homes is rising fast. But in the absence of a full-blown collapse of house prices—which, though possible, is by no means assured—America is a long way from recession. A period of sluggish growth is a far more likely outcome. And with inflation straining at the leash, that is exactly what the economy needs. Moreover, it needs it to last much longer than many people realise.
Unwinding the excesses
An extended diet of sub-par growth is essential to quell rising price pressure. It is also the only way to unwind the imbalances—households’ heavy debts and negative saving rate, the vast current-account deficit—that are the legacy of Mr Greenspan’s loose monetary policy. Few in America like to admit this. Even the Fed foresees only a couple of quarters of sluggish growth this year before the economy bounces back in 2007 with inflation declining nonetheless. That makes no sense. Unless demand growth stays weaker for longer than they now expect, the central bankers will neither get the economy back into balance nor quash inflation.
And the need to get a grip on price pressure is becoming more urgent. Every measure of inflation has been too high for months. But many discounted the risks involved, largely because productivity growth was strong and wage pressure weak. If firms were becoming ever more efficient and wages were stagnant, the chances of a nasty wage-price spiral seemed low. Recent revisions to America’s national accounts, however, suggest less room for complacency. Productivity growth seems to have been lower and labour costs higher than initially thought. The new figures say wages are accelerating: America’s total wages and salaries rose by 6.8% in the year to the second quarter of 2006, the most in six years.
Add together the need for a period of slower growth and the greater danger from inflation, and the unavoidable conclusion is that interest rates must go up again. After 17 rises in a row, Mr Bernanke may be tempted to call for a time-out. It is a temptation he should resist.
In case the link to the other article does not work (as it may not w/o a subscription), here is the byline and the money quote from that article:
————————————————————————————————–
Leaders
America’s economy
Danger time for America
Jan 12th 2006
From The Economist print edition
The economy that Alan Greenspan is about to hand over is in a much less healthy state than is popularly assumed
…
But the main reason why America’s growth has remained strong in recent years has been a massive monetary stimulus. The Fed held real interest rates negative for several years, and even today real rates remain low. Thanks to globalisation, new technology and that vaunted flexibility, which have all helped to reduce the prices of many goods, cheap money has not spilled into traditional inflation, but into rising asset prices instead—first equities and now housing. The Economist has long criticised Mr Greenspan for not trying to restrain the stockmarket bubble in the late 1990s, and then, after it burst, for inflating a housing bubble by holding interest rates low for so long (see article http://www.economist.com/opinion/displaystory.cfm?story_id=5381959 ). The problem is not the rising asset prices themselves but rather their effect on the economy. By borrowing against capital gains on their homes, households have been able to consume more than they earn. Robust consumer spending has boosted GDP growth, but at the cost of a negative personal saving rate, a growing burden of household debt and a huge current-account deficit.
Burning the furniture
Ben Bernanke, Mr Greenspan’s successor, likes to explain America’s current-account deficit as the inevitable consequence of a saving glut in the rest of the world. Yet a large part of the blame lies with the Fed’s own policies, which have allowed growth in domestic demand to outstrip supply for no less than ten years on the trot. Part of America’s current prosperity is based not on genuine gains in income, nor on high productivity growth, but on borrowing from the future. The words of Ludwig von Mises, an Austrian economist of the early 20th century, nicely sum up the illusion: “It may sometimes be expedient for a man to heat the stove with his furniture. But he should not delude himself by believing that he has discovered a wonderful new method of heating his premises.”
And just in case the link to the article on AG’s retirement accolades is not accessible, I quote the section most relevant to this thread below.
Notice the three episodes which The Economist (an objective source!) classifies as the three biggest stockmarket bubbles in the past century, and meditate on the fact that the ensuing denouement has only finished playing out in two of the three.
This article raises a tricky issue for Bernanke: Stop leaning into the wind when other CBs (BOJ, BOE, RBA, ECB) are doing it and your currency may get blown over. And notice that the recent statistical evidence (contrary to what we saw as of Jan 12th) suggests that $US inflation is no longer safely under control…
———————————————————————————————-
Alan Greenspan
Monetary myopia
Jan 12th 2006
From The Economist print edition
The accolades bestowed upon Alan Greenspan ahead of his retirement on January 31st have a strong whiff of irrational exuberance
…
How monetary policy should respond to increases in the prices of assets such as houses or shares is the biggest dilemma facing central banks everywhere. The Fed takes account of rising asset prices to the extent that they boost spending and hence future inflation. But the burning question is: should it respond to asset prices even if inflation seems under control? Three main arguments are given by Mr Greenspan and his colleagues for why central banks should ignore asset prices other than their impact on inflation. First, that monetary policy focused on inflation and growth is the best way to achieve economic stability. Second, that one can never be sure that what looks like a bubble really is a bubble. And third, that interest rates affect the economy more like a sledgehammer than a scalpel. A modest rise in rates is unlikely to halt rising share prices, but an increase sufficient to pop the bubble would slow the whole economy and could even cause a recession. Mr Greenspan thus concludes that it is safer to wait for a bubble to burst by itself and then to ease monetary policy to soften a downturn.
Consider each of these arguments in turn. First, the job of a central bank is not just to prevent inflation, but also to ensure financial stability. Yet the three biggest stockmarket bubbles in the past century—America’s in the 1920s and 1990s and Japan’s in the 1980s—all developed when inflation was low. Arguably, Mr Greenspan has defined the role of monetary policy too narrowly. Inflation is often described as too much money chasing too few goods. But in a world awash with cheap money and with potent new sources of supply, such as China, to hold prices down, inflation will remain low and so fail to signal if an economy is overheating. Increased central-bank credibility also helps to anchor inflation. If central banks hold interest rates low, this will encourage risk-taking in financial markets and excess liquidity will spill over into asset prices rather than traditional inflation (see chart 2).
Asset-price inflation can be as harmful as conventional inflation. A sudden collapse in share or house prices can trigger a deep downturn. And surging asset prices also distort price signals and cause a misallocation of resources—by encouraging too little saving, or too much investment in housing, so reducing future growth. This is why central banks need to pay closer attention to asset prices.
Second, it is not, as Mr Greenspan argues, impossible to identify bubbles. When prices have lost touch with fundamentals and there are other signs of excess, such as rapid credit growth, alarm bells should ring. Mr Greenspan’s “irrational exuberance” speech in December 1996 shows he was concerned about a bubble inflating long before the bubble reached its full extent. And transcripts of meetings of the Federal Open Market Committee (FOMC, which meets to set interest rates) now make clear that several Fed officials were fretting about the bubble in 1998 and 1999. At the December 1999 meeting, when discussing the stockmarket, Mr Greenspan said: “It is only a question of how much of a bubble there is.”
Moreover, central banks do not have to be certain they have identified a bubble before they act. Monetary policy has constantly to deal with uncertainty—such as the size of the output gap. Uncertainty is a reason for responding cautiously, but not for doing nothing.
What of Mr Greenspan’s third claim that, even if a central banker is pretty sure there is a bubble, there is little he can do about it because interest rates are a blunt tool? In August 2005 Mr Greenspan said: “Given our current state of knowledge, I find it difficult to envision central banks successfully targeting asset prices any time soon.” But he was setting up a straw man. Nobody is seriously arguing that central banks should “target” a particular level of asset prices. Most economists accept that aggressive action to “prick” bubbles could also be risky. Instead, the debate today is whether central banks should “lean against the wind” when asset prices appear dangerously out of line with fundamentals, raising interest rates by a bit more than inflation alone would call for.
Beyond inflation
Contrary to what Mr Greenspan said, some central banks are already doing exactly that. The Bank of England and the Reserve Banks of Australia and New Zealand have raised interest rates in recent years by rather more than inflation alone justified, because of concerns about house prices. Mr Greenspan is also wrong to argue that only a big rise in rates can halt a bubble. In both Britain and Australia, rate increases of just 125 basis points, along with clear warnings from the central banks that house prices were overvalued, were enough to slow the annual pace of house inflation from around 20% to close to zero.
I can bet anything that the fed will not increase interest rates next. Look for stocks and commodities to rally and dollar to fall. Ben Bernanke as Fed chairman is a greater tragedy than Greenspan. He’s a total dove at thecore and has no balls to take recession and save the system. get out of dollar fast - its already lost its purchasing power since he was made the chairman and will continue to loose its power.
I guess lots of folks would have “bet anything” on no hike in May 2006 either, which explains the crashes in emerging stocks and gold prices which subsequently took place…
Ahhh shucks, the Keynsian Inflation vs Economic growth formula is busted again. It was busted in the 90s with low unemployment and low inflation, and in the 70s with high unemployment and high inflation. My bet is for there to be more rate raising. The dollar is in too much trouble right now, and inflation is picking up.
The stock market, the bond market, and fed funds futures market is telling Ben what to do, and he better do what he’s told.
William McChesney Martin’s ghost begs to differ with you…
‘To the present day, his term as Chairman is the longest term the Board of Governors has seen. Over nearly two decades, Martin would achieve global recognition as a central banker. He was able to pursue independent monetary policies while still paying heed to the desires of various administrations. Although the objectives of Martin’s monetary policy were low inflation and economic stability, he rejected the idea that the Fed could pursue its policies through the targeting of a single indicator and instead made policy decisions by examining a wide array of economic information. As Chairman, he institutionalized this approach within the proceedings of the FOMC, gathering the opinions of all governors and presidents within the System before making decisions. As a result, his decisions were often supported by unanimous votes on the FOMC. His most famous quote about his central banking philosophy was, “The job of the Federal Reserve is to take away the punch bowl just when the party starts getting interesting,” referring to the need to raise interest rates when the economy is at its most active.’
http://en.wikipedia.org/wiki/William_McChesney_Martin,_Jr.
The below quote is from a post on another thread of a salon.com article by Brad Delong which seems to belong here. It explains why the Fed’s hand will quite likely be forced to tighten this week, contrary to Wall Street fantasies about their respiking the punchbowl. Personally, I cannot see yesterday’s little one-period statistical blip in the jobs numbers as grounds for changing course, but then I myself am no politician. Note that the import price inflation risk Brad mentions was far less of a constraint on the Fed in previous business cycles, as globalization has greatly increased our economic dependence on cheap imports.
BTW, I liked Brad’s oblique reference to my favorite Herbert Stein quote (”Anything which cannot go on forever will stop.”) in the home equity-ATM context. Even though all who regularly post and read here already know this, it is great to hear a prominent mainstream economist concur.
—————————————————————————————————-
The odds of economic meltdown
With interest rates and oil prices rising and consumers spending beyond their means, we may be headed for recession — and worse.
By Brad DeLong
Pages 1 2
Aug. 3, 2006
http://www.salon.com/opinion/feature/2006/08/03/recession/index.html
…
The Federal Reserve is also unwilling to stop increasing interest rates because it is afraid of recession risk factor No. 2: a rise in oil and import prices. Those fears are justified. Remember how the invasion of Iraq, besides bringing a golden age of democracy to the Middle East, was also supposed to produce $15-dollar-per-barrel oil? Oil is now at $75 a barrel, and this rise in oil prices is putting upward pressure on prices in general. As for import prices, they are vulnerable to a U.S. dollar that has been weakened by the Bush budget deficit and massive borrowing from China. Suppose the dollar declines suddenly, which is not a far-fetched possibility. Should the dollar fall by, say, 30 percent, and should importers raise their dollar prices in proportion, then the one-sixth of U.S. spending that is spending on imports will see prices rise by 30 percent. Because 30 percent times one-sixth equals 5 percent, that would boost U.S. consumer prices by 5 percent nearly overnight.
Thus there are two big reasons for the Federal Reserve to keep raising interest rates, in spite of how much downward pressure on demand is still in the pipeline. The Federal Reserve thinks it needs to do so in order to establish its long-term credibility, and there are the twin dangers of oil- and import price-triggered inflation to guard against.
Most likely the Federal Reserve’s continued raises in interest rates will not send the economy into recession. But there is that chance, and the chance is raised from a low-probability possibility to a serious worry by the third factor: that home-as-ATM problem. The unprecedented use of home loans to squeeze cash out of equity has allowed middle-class consumers to spend well beyond their means. Someday this spending spree has to come to an end. If it comes to an end suddenly, at a time when the Federal Reserve has raised interest rates a little too much, then we have our recession.
Make no mistake about it: The U.S. economy is close to the edge. Retail sales in the second quarter were rising at only a 2.1 percent annual pace. Business investment in equipment and software was falling. Residential construction was falling. Either households will continue spending beyond all reason, or businesses will start boosting investment, or exports will start booming, or there will be a recession sometime in the next year. Figure the odds at 3 out of 10.
What can be done to head off the danger? Unfortunately, very little. The bag of macroeconomic tricks is empty. In 2000-2001 the Federal Reserve could lower interest rates to the floor, boosting residential construction and consumer spending to offset the decline in high-tech investment, and turn the 2001 recession into a very small event indeed. In 2002-2003 the short-run stimulative effect of the Bush tax cuts came online at exactly the right moment to offset fears of a deflationary spiral. But today further fiscal stimulus would increase global imbalances — meaning, raise the trade deficit — and do more damage to confidence than it might do good in curing a recession. And sharp reductions in interest rates would lower the value of the dollar and increase inflationary pressures from import prices in a way that the Federal Reserve does not dare allow.
The past 24 years have been an amazing run as far as the business cycle is concerned. There have been only two recessions, and both of those were short and shallow. But Ben Bernanke and Co. are now at real risk of presiding over the third.
I just don’t see the FED stopping before 6% as they don’t need to, with being able to phantom inflate with M3 being hidden and all. A hike this week might do wonders for the dollar and commodity prices, all the while Ben chuckling to himself as he decides how many zeros to add to the money supply.
So, after 17 consecutive rate hikes by the fed, which everyone is crying about, what is the current fed funds rate? 13%? 15%? 17%? NO, it’s a measly, historically low 5.25% The inflation monster cannot be stopped by a measly 5.25% fed funds rate.
I agree with you Mike. That’s what’s crazy about all the market leaders crying about an under 6% rate.
I only have learned from what I’ve read here in about 6 mos. but I’m hoping for a hike. I want people (and our government) to stop spending like someone’s going to drop a bomb on us tomorrow.
IMHO I find it hard to believe that the rate increases we’ve incurred so far are going to inspire people to start saving. I see business as usual around me.
The media report on housing but still don’t point out the full economic picture to the masses. The punchbowl is growing stale but its still out.
I hope for a .5% raise with an announcement of no further rate hikes this year. This would allow to observe how the previous hikes work through the economy and if they are sufficient to restrict inflation. The bond market seems to think that even the current rate is enough.
I think the FED should raise rates and probably will raise them. The FED needs to worry about inflation accelerating and the dollar decline needs to be slow and carefully done. A few housing speculators should not bother the FED too much. But we have a bond market yeild curve that suggests a recession so I really won’t be too suprised if the FED pauses. Then I’ll probably load up on Gold miners and oil stocks…. me and thousands of others, some who have very big dollar holdings… like the Chinese. should be interesting.
I suggest a new parameter for the FED to target: Wage Inflation
Many have observed that the FED’s power is shrinking, as the US’s share of the world economy is. Commodity prices depend now more on what China and the Bank of Japan are doing than on the FED. Higher import prices increase inflation in the US but are beyond control. If the US looses economic power internationally, it shouldn’t be the FED’s job to behave as it hasn’t happen and to hurt the US economy in the course. What is not beyond control are wages in the US: Instead of targeting inflation, the FED could give target of wage growth, say 3%, and adjust interest rates according to that. The target allows wages to grow and to shrink relatively to each other, without forcing nomial wage cuts, which gives the needed economical flexibility. It would still reward saving, because people could estimate from the interest they are getting on savings how deferring consumption into the future would be rewarded. One consequence: From the current rate of wage inflation to judge, the FED should be CUTTING rates. What would be advantages, disadvantages of the FED targeting wage inflation?
It’s something that would be very hard to measure. When someone gets a raise, how would you know, at an aggregate level, whether it was inflation-related or merit-related?
If you pushed up wages as arbitrarily, you risk companies outsourcing more.
In all the discussion about the huge money supply, the resulting inflation and the FED I miss one very big item….. the fractional reserve rate.
This paper http://www.itulip.com/forums/showthread.php?t=292 explains much better than I can that the liquidity deluge over the last 10years did not come from the FED directly. I was the decision of the FED to lower the fractional reserve rate to essentially zero which allowed the banks to create credit almost without reserve deposits.
If you have any deposits at a bank you better read this paper and contemplate if you have any chance of getting your money out if more than the average people show up to withdraw.
IF the FED was serious that they want to reduce the liquidity in the system, it would be much more efficient to impose a higher fractional reserve requirement for the banks. As long as they don’t do that, they are not serious about decreasing the liquidity or risk in the system. IMHO they are pegging their monetary adds at a 5% growth channel (last 3 years) and setting the interest rate at a level which already was determined days before by the money markets.
At the moment the overnight FED money market rate does not indicate an increase. The FED would need to actually decrease their average adds to the SOMA (system open market) to a lower than 5% growth rate (which to have not yet done over the last 3 years) to force the overnight landing rate up 0.25% .
YES, they did NOT yet decrease the increase in money supply over the last three years.
But as said before…… I only believe the FED is serious about squeezing the liquidity if they increase the fractional reserve requirement at the banks.
“I was the decision of the FED to lower the fractional reserve rate to essentially zero which allowed the banks to create credit almost without reserve deposits.”
This brings to mind homes purchased with zero downpayment, which enables buyers to purchase homes (using 100%-financed I/O Option ARMs) with a fraction of the income needed to pay off the loan over the long run…