Matt Nolan

Why might the Fed lift rates?

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There is talk that the US Federal Reserve may begin lifting interest rates again in August.

Now this is something that some commentators find unusual (*) (*). However I think it is consistent for Dr Bernanke to slash rates as he has and then turn around to tighten, given the way he views inflation targeting.

Fundamentally, we have seen two very different reactions to a domestic economic slowdown in Europe and the US. In Europe inflation targeting means sticking to your guns on the annual growth in price measure in the economy – and just looking at other economic variables as a secondary concern.

This view of inflation targeting is justifiable given the inherent commitment game that is required to stabilise growth in the general price level in the economy – however, from a welfare maximising point of view it “may” be too black and white.

In the US, Dr Bernanke is also a proponent of inflation targeting (book and a good speech). I get the impression that he enjoys inflation targeting for its ability to anchor inflation expectations – giving the bank the chance to “deviate” from its mandate temporarily to ease economic conditions.

However, this view of inflation targeting has one major catch – the Bank must stay credible! Read more

Matt Nolan

April 08 US economy: Rate cuts finished?

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Today the US Federal Reserve cut their cash rate by 25 basis points to 2%.  At the same time data was released stating that GDP growth in the US was 0.6% (annualised, seasonally adjusted) in March – a weak number to be sure, but positive and higher than market expectations.

The first thing to take from today’s announcements is that, given the balance of probabilities, rate hikes are finished (see Calculated Risk for a comparison of statements).  Now with inflation running at over 4%, the real interest rate is currently negative – implying that the Federal Reserve is now in a position where it has to be extremely careful.

For New Zealand, negative real interest rates in the US imply that investor interest in commodities (as a store of value) is higher – so this is a good thing.  However, the end of interest rate cuts in the US may see our dollar loss a touch of traction against the US.  This would probably be a good thing for exporters, except that the US is cutting back on its import of NZ goods (see the 27% tumble in the value of NZ exports to the US in March).

On the GDP side, the (relatively) strong performance of the industrial production index and the weak performance in retail did indicate that either exports or inventories were going to have a hell of a quarter.  Instead we got a mix – exports did well, inventories rose.

Looking at the numbers, inventory accumulation appears to be partially payback for the huge rundown in the December quarter.  However, given that none of the analysts I’ve looked at said anything about it, it is likely that inventories were bloated before the December quarter anyways.

What does this mean for NZ – nothing.  Our dollar hardly moved, there is still a feeling we are sitting on a knife-edge with the world economy.

jamesz

Politicians making a difference

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I’ve just come across a post from a week ago by Dani Rodrik which previews a forthcoming book by Larry Bartels. The post includes this fascinating diagram:

What this diagram shows is the percentage growth in income under a Republican and a Democratic administration over the course of a four year Presidential term. It gives the lie to the common assertion that it doesn’t matter to the ordinary citizen who is in power. Read more

Matt Nolan

March 08: Fed cuts rates to 2.25

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Another month, another 75 basis point rate cut by the Fed. This is (close to) what the market expected, so I can’t imagine that it would have much impact on anything. However, the statement was interesting.

Does anyone else find it interesting that the Fed cut rates by 75 basis points but still wrote a whole paragraph (1/3 of the meaty bit) on the risk of accelerating inflation compared to last time when they said:

The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

The most interesting bit was:

Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.

If the CPI measure ticks up, will this be the end of rate cuts?

jamesz

Moral hazard in the Bear market

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Megan McArdle worries a little about the moral hazard problem that JP Morgan and the Fed’s ‘rescue’ of Bear Stearns creates (although her major point is that we should be relieved that it was rescued from default). knzn’s take on the issue puts the problem in perspective:

[Hypothetical future investor]: I own a major stake in an investment bank, and I’m getting concerned about their risk management. Should I bring this up at the shareholders’ meeting?

[Hypothetical friend]: I don’t see why. What’s the worst that can happen? The bank will go sour, the Fed will arrange a bailout, and you’ll only lose 95 percent of the money you invested, 96 tops. What’s the big deal?

Matt Nolan

Externalities and Fed monetary policy

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An interesting article by Sebastian Mallaby discussed the contrary monetary policy strategies of the US Federal Reserve (cut rates to avoid a recession) and the European Central bank (keep rates elevated to avoid inflation). (h.t. Greg Mankiw)

In the article, Mallaby alludes to the view that the US Federal Reserve might feel that it is the greater protector of the world economy – this takes for granted the positive externalities to the rest of the world from the Fed cutting rates. These are:

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