April 28, 2005
Global Trader's Diary Answers The Bell
Michael at the Global Trader's Diary provides a thoughtful critique of Fed policy:
I don't really have problem with Fed policy until around Nov 1998 and I think these issues are best addressed by Paul McCulley's more constructive Fed criticism from March of 2000:
Which brings us to the question of whether the interest rate tool is the right exclusive instrument for dealing with the problem. I know of no economic model that postulates a high interest elasticity of demand for lotteries! Virtually every economic model incorporates, however, a high interest elasticity of demand for the goods and services of the Old Economy.
Thus, using the interest rate tool exclusively to thwart wealth creation in New Economy stocks carries grave risks for the Old Economy...
Under Regulation T, the Fed has the authority to set initial margin requirements for the purchase of stocks on credit, which has been at 50% since 1974. The Fed should raise that minimum, and raise it now.
That's an interesting comment. The November 1998 date gets my attention because, well, I don't actually disagree. The record shows that my boss at the time, Jerry Jordan, actually dissented on the rate cut from that meeting on the grounds that it was too much ease:
Mr. Jordan dissented because he believed that the two recent reductions in the Federal funds rate were sufficient responses to the stresses in financial markets that had emerged suddenly in late August. An additional rate reduction risked fueling an unsustainably strong growth rate of domestic demand.
That, in fact, was his fifth dissent of the year. Prior to the rate cut in September that year (following the Russian currency crisis and LTCM debacle), Jerry had been arguing that the best course was to remove what he believed to be an excessively stimulative stance of monetary policy. In his dissents, I saw the same sentiment that was just recently articulated by my current boss:
How, then, should monetary policy deal with current account imbalances today? I do not think that the FOMC should take preemptive measures to address these imbalances. However, I do think that the Committee should continue to bring the federal funds rate target to a level that is consistent with maintaining price stability in the long run. If we achieve that, then we will be in a position of strength to address whatever challenges arise.
It is good to have conversation about whether mistakes have been made, or are being made, in achieving that goal. It is productive to have intelligent critiques of the regulatory practices of the Federal Reserve, and generate discussion on whether those practices contribute to financial stability, or not. (Although I do not generally think of these responsibilities under the heading of "monetary policy" -- they are the province of the Board of Governors, not the Federal Open Market Committee.) I objected to the Roach article because it was not all constructive. The GTD post is.
While defending Roach's piece is a bit difficult, I am not that comfortable absolving the Fed either.
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