Fed Rate Cut
The Fed will make the official announcement of an interest rate cut tomorrow. At least that is what everyone has been reporting, and the odds of the Fed not cutting after the signals it's given are very low. But in the time since this has become the accepted version of what will happen, many in the press have started to second guess the rate cut (while more relevant analyses debate the wisdom of a 0.25 versus 0.5 percent cut).
A New York Times editorial today advocates strong consideration of no change in rates: "This might be a time for Mr. Greenspan to stand pat, even if it means disappointing stock traders for a day or two." They base the argument on the evidence that deflation now looks unlikely. Daniel Gross writes in Slate of another worry--a possible increase in short-term borrowing costs for companies that may result from extremely low money-market returns affecting the commercial paper market. The Wall Street Journal added in yesterday's edition that the ref="http://online.wsj.com/article/0,,SB105611429520383400,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs">"Fed's Rate Decision Could Pose Threat to Recovery in Europe." Here's the thesis:
"The big concern for Europeans is that if the Fed cuts rates, the gap between U.S. and European interest-rate levels will increase, further weakening the dollar and strengthening the euro, which makes European exports more expensive on international markets. In that case, the effect of a stronger euro could overwhelm the short-term boost a recovering U.S. economy -- and rallying Wall Street -- could offer Europe. Already, analysts say, European stocks look like a risky bet; their riskiness likely will increase in the months ahead if the Fed cuts rates."
Larry Kudlow makes the case for a cut of 50 basis points on National Review Online:
"For nearly three years the Fed has erred on the side of deflation. Now they must err on the side of reflation. The 50-basis-point rate cut last November was a decent beginning, but in the context of a deflationary slump worldwide the Fed cannot afford to take any chances. A revived stock market is signalling that a better economy is ahead. But we've had disappointments before, and that is why the central bank should take out an insurance policy of additional ease."
This basically comes to the opposite conclusion as the NYT, seeing deflation as more of a threat. And rather than putting Europe in a bind, as WSJ warns, Kudlow sees the cut as a way for the US to lead global monetary policy:
"By the way, a strongly accommodative Fed policy that keeps the American economy flush with cash will force foreign money masters--like those in western Europe and Japan--to do the same. Otherwise the U.S. dollar will keep floating downward, putting foreigners at a big disadvantage. The Fed has a global responsibility to lead on reflationary money expansion. Then the international maestros will follow."
Meanwhile, Bruce Bartlett of NRO argues that the lag between the rate cut and seeing the effect makes him cautious. He also raises the relevant point that the Fed may not want to ease any more after this for fear of being accused of aiding Bush's re-election bid (in fact they may not want to tighten either, he claims, hoping to make monetary policy an non-issue in the 17 months ahead).
I'm not sure if the Fed needs to totally shut down the option of a further rate change so far out from November '04, but I agree with the essence of Bartlett's case. The lag is a real issue, and if the economy is starting to recover now, as many economists are claiming, this is exactly the wrong time for a monetary stimulus. Why not cut 25 basis points, and if the economy continues to falter cut 25 more? At least we are left with some wiggle room if the smaller cut prevails. If we cut 50 now and that doesn't work, then what? The rate would be a Japan-like 0.75 percent.
And speaking of Japan, Kudlow is incorrect, I believe, to think that a US cut can simply force the hand of other countries. As has been well documented, Japan, a country Kudlow mentions, has rates so low that cutting them more is problematic. Europe's monetary policy is a complicated beast too.
In light of the CPI report last week, the deflation fears should subside to the point where the 0.25 percent cut is sufficient at present.
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