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February 06, 2006
And The Funds Rate Probabilities Say: 50/50 For Five
Last week I provided a defense of monetary policies that err on the side of being overly aggressive on the inflation watch, using the 1994 rate hikes and their aftermath as a case study. Several people -- Jim Hamilton included -- suggested I might be guilty of a bit of cherry-picking, selectively choosing one of the episodes that worked out well when there are plenty of others that (apparently) worked out less well.
That is fair enough and, as James points out, there will indeed be episodes where I might "regret [policy] tightening as much as it did." But this is somewhat like regretting the purchase of fire insurance because your house didn't burn down -- we might have been better without the insurance after-the-fact, but prudent risk management suggests that betting on that outcome is not the wisest course.
But here's the rub: The policy users guide is missing a few pages in the section describing what constitutes "prudent risk management." In my post I emphasized inflationary pressures. Jim emphasized real economic growth and, not unwisely, continues to worry about driving the spread between long- and short-term rates to levels that are disproportionately associated with economic weakness.
Jim won't be happy with this week's estimated funds rate paths:
Today the ten year Treasury yield closed at 4.54%. I'm pretty sure a 50% chance of another 50 basis points on the funds rate by May is not the sort of caution Professor Hamilton is looking for.
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