Wednesday, March 21, 2007

Time for the Fed to Cut

Memo to the Fed. Inflation is a lagging indicator, job growth is a lagging indicator. It's becoming obvious that the only thing that could derail this Goldilocks economy is an overzealous Fed worrying about non existent inflation. The last six months average of core inflation is 2%, well within the Fed's comfort level. For greater articulation read below........

Why the Fed Didn't Raise Interest Rates
Inflation is running above the levels that Bernanke has targeted, but he's holding off on hiking rates because of the risks

From Peter Coy - Businessweek 3/21/07

Imagine you're driving a car with a blacked-out windshield and a loose steering wheel. Now imagine that your car is the $13 trillion U.S. economy. That should give you some idea of what it feels like to be Federal Reserve Chairman Ben S. Bernanke. Yes, in a word: scary.

Bernanke and the other members of the Fed's Open Market Committee pleased the stock market Mar. 21 when they voted to keep the federal funds rate at 5.25%, and slightly softened their anti-inflation stance in the accompanying statement.....

...Accounting for Lag Time

Give credit to Bernanke: He still wants to get inflation back under 2%, but he's willing to let it happen a little more slowly than he expected when he took over as chairman in February, 2006.
The U.S. economy really is like that car with the blacked-out windshield (so you can't see ahead) and with loose steering (so there's a big delay between the time you turn the steering wheel and the time you get results).

Inflation, in particular, responds with a long lag to whatever the Federal Reserve does. It stays high for awhile even after the economy has begun to slow. If the Fed didn't compensate for the lag, it might oversteer and put the economy in a ditch. Recognizing that, Bernanke and the other FOMC members are willing to allow some extra time to see if the tightening to date, from a funds rate of 1% to a current rate of 5.25%, will gradually cool inflation.

The last recession shows how long you sometimes have to wait to see inflation finally fall. In the late 1990s, the Fed raised rates nearly two percentage points to stamp out inflation. But the first victim of the rate hikes was growth. The economy tipped into a recession in March, 2001. Even then inflation stayed stubbornly high. Core inflation excluding food and energy prices didn't fall below 2% until January, 2003, notes David Rosenberg, chief North American economist of Merrill Lynch (
MER). By then the Fed had already slashed interest rates more than five percentage points. A good thing, too—if the Fed had waited to cut rates until inflation had already fallen, the 2001 recession would have been much longer and deeper.

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