Close Call

The reference here isn’t to the actual hurricane (which was far from that if you were black, poor, and lived in downtown New Orleans) but to the economic ‘near miss’ I think we are watching, and to the difficult decision Alan Greenspan and his team will now have to take on 20 September next.

The blogs are of course rife with speculation.

Update: Dave at MacroBlog just came up with one more reason the Fed might steadfastly remain on course: poor productivity readings.

Probably the best starting point would be Dave Altig at MacroBlog – who regularly monitors estimates of prospective federal funds rates extracted from options on funds futures contracts. As he indicates the expectation of a pause after a 25 basis point increase next week has taken the now taken the lead over the expectation of a raise. However it should be noted that this situation is extremely volatile given the levels of uncertainty following in the trail of Katrina, and given that there are still nearly two weeks to go. And two weeks in a fast moving situation, well, that’s a heck of a long time.

So this gives all us budding blog-economists plenty of time to position ourselves. James Hamilton (Econbrowser) goes for a pause:

Finally, there is the ever-present question of what will the Fed do? I think– and hope– that they will take this as an opportunity to pause and see what these developments will bring.

Mark Thoma (Economist’s View) more or less agrees:

Should the Fed do what it thinks is correct according to the fundamentals, or does it behave according to market expectations it disagrees with? …Unless FedSpeak can convince markets otherwise (and assuming FedSpeak would want to), it may be prudent from a risk management perspective to pause and wait for expectations of the Fed and the private sector to converge before considering further rate hikes.”

Over on the other side of the Atlantic we appear to take a different view of things. New Economist still thinks the Fed *should* go ahead:

But looking at the Fed funds rate expectations chart again, a majority of market participants still favour a 25 bp rate hike to 3.75% later this month. I’m with them – though I don’t consider a short-lived pause would do any harm, provided it was clearly signalled as such.

And I, gentle reader, agree with New Economist: I think there is no big issue – precisely because the steps are measured – and on balance I think the Fed should and will continue. Let me explain a bit more.

Consider this. The fed has made a very big deal of stressing the distribution of risk, upside or downside, and of identifying situations where that risk is asymmetric. Now what we have is ‘measured raising’, and one of the virtues of this is that it goes in ‘baby steps’. So I think the decision – which will really depend on how one or two key people incline – will hang on whether you give more importance to the value to be garnered from not rising one extra quarter point now, or to the danger that you could give the wrong impression to global markets (who always seem to suspect that Greenspan knows more than he’s telling) and have a more negative impact on global growth expectations than would be justified by the US impact of not raising. The more I think about it, the more this latter one convinces me.

Add to this the political pressure inside the US to pause, and the need for the Fed, and especially in the run-in to the change of Chairman (I mean imagine just for one moment someone somewhere was considering appointing Bernanke, Bush’s current CEA) the need for the Fed to maintain its clear independence and ability to resist pressure. So I think OECD chief economist Jean-Philippe Cotis advice to the Fed today:

The OECD delivered recommendations to each of the four most important central banks, some of which will not be received gratefully. Mr Cotis said he thought the underlying strength of the US economy left it well placed but the rise in oil prices without any corresponding pick-up in core inflation meant monetary policy tightening could be slowed. “The Federal Reserve should continue to move back towards neutrality, although possibly at a more measured pace than hitherto” Mr Cotis said

At the end of the day, this sort of ‘advice’ doesn’t really help central bankers to take decisions: they already know what he is saying. It just adds to the pressure. And as to a *more* measured pace, well what could be more measured that what the Fed are doing right now?

And remember, with measured increases, you could pause next month and/or the one after, when the Katrina effect will have been much better assimilated. I think in terms of helping to sustain US growth towards the back end of this year working with the IEA to keep supply at the pumps steady could be much more important than any interest rate decision of this magnitude. So as I said, it’s a close call, but I now think that on-balance the Fed should go ahead.

This entry was posted in A Fistful Of Euros, Economics and demography and tagged , , , by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

2 thoughts on “Close Call

  1. What’s the current thinking on the idea that the opportunity will be taken to replace the Fed system with a more collegiate one when Greenspan goes? Central Banking Journal (them of the Ken Clarke Euro scoop) seem to think it’s likely.

  2. “What’s the current thinking..”

    Well, you really have drawn a blank here Matthew, I actually have no idea. The main debate I have seen is about whether they should go for a policy rule or not. Whatever the ultimate outcome, I think things are about to get interesting. Following Greenspan could be a nightmare for someone (remember Bobby Robson and Johann Cruyff here at FC Barcelona?), and as I’m saying here, the decisions this year have been relatively straightforward – hurricane or no hurricane – the difficult decisions look like they could come next year.

    “them of the Ken Clarke Euro scoop”

    And whatsmore, them of the Charles Goodhardt open letter to Trichet, which I thoroughly enjoyed and mainly agreed with.

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