Man Without Qualities

Tuesday, January 28, 2003

The Feds

There are reports that the Federal Reserve Bank will hold rates steady when it meets today, largely because Congress is expected to enact a stimulus plan and the Fed does not want to be engaged in overkill. The coming war is also presumed to be bad for the economy in ways the Fed can do nothing about.

It's a curious argument. Any fiscal stimulus plan is an uncertain proposition as immediate short term economic stimulus simply because what is given to consumers as tax cuts is, in the aggregate, removed from the bond market. The "stimulus" comes from supposedly giving the immediate use of the money to people who will spend it (often presumed to be lower income consumers) and withdrawing its use from people who save. This kind of calculation is notoriously uncertain (see, for example, Japan over the last ten years) and, worse, slow.

It would be strange for the Fed to hold off on a rate cut until the war is over. Indeed, war tends to frighten people into conservative investments, and stimulating the economy short term through an increase in liquidity becomes even more important. Of course, longer term wars can increase inflationary pressures - but that is a long way off.

There is sluggishness in the economy, no risk of inflation and concern that the housing market, which has provided much of recent support, may turn sluggish. The Fed could therefore do a great deal of immediate good by cutting short term interest rates, especially by reducing one specific reason for the housing market to soften - a softening which could have serious near term effects. Absent fear of a "housing bubble," there is no good reason for the Fed not to cut rates right now.

My guess is that they know that. We'll know around 2:15 p.m. (1915 GMT).

UPDATE: The Fed left rates unchanged, which, in my view, was a fairly serious mistake.

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