The Economy in the Fed’s Hands?
really know what Alan Greenspan is up to? Does the Maestro himself
know why the Fed’s target interest rate has been robotically
raised eight consecutive times, with no end in sight? Is there
a theory behind this money-tightening policy that can justify
the threat it poses to future economic growth?
example, the latest monetary data from the Federal Reserve Bank
of St. Louis. The data show a marked slowdown in key money-supply
measures. The adjusted monetary base, over the past six months,
is growing at a meager 2.6 percent annually. A broader money measure
known as M2 has slipped to a below-normal 3.5 percent.
be two key reasons for this money slump. First, the Fed is injecting
less and less new cash into the economy as it raises its short-term
target rate. Second, the increase in short-term rates to 3 percent
from 1 percent may be reducing future economic demand.
of the monetary readings is now way below the 6 percent growth
of current dollar GDP. While the fit between money and national
income is a loose one, it is not irrelevant. It could be predicting
a sub-par economy next year.
targeting inflation-sensitive, forward-looking market-price indicators
-- what supply-siders call adhering to a “price rule”
-- Keynesian fine-tuners at the Fed are up to their old tricks.
It’s sort of like George W. Bush’s strategy for Social
Security reform: When it comes to policy targets, everything is
on the table for the central planners at the Fed. Vladimir Putin’s
remaining Soviet-style bureaucrats have nothing on our money-meddlers
apparent that Greenspan is not targeting market-price indicators.
So what is he targeting? Maybe he has the so-called housing bubble
in his sights, or the mortgage credit-expansion behind it. If
he is watching housing, he’s looking the wrong way. The
key reason behind the surge in housing investment is the shower
of tax advantages that have fallen on this sector since the 1997
tax bill. On a tax basis, it’s much better to invest in
homes than in stocks as home-sale profits are tax-free up to $500,000.
Street investment manager asked me when the Fed is going to “fix”
housing. I asked him, “Do you mean that Greenspan should
get a ladder and a paint bucket and actually begin work on a house?”
“No, no,” he said. “When will the Fed stop the
bubble?” To which I responded, “That’s not the
a bubble in Naples, Florida. But there are no bubbles
in Syracuse or Hartford. Or do the central planners at the Fed
think their mandate extends to controlling the local economies
of each and every American city?
In the last
economic cycle the Fed ignored falling inflation and instead aimed
its guns at the Internet bubble. We soon were reminded that any
time you deflate the money supply, the overall economy slumps
badly. Stocks delivered their worst performance in over 40 years.
As for signs of inflation today, the price of metals and overall
spot commodities are dropping, gold is going nowhere, and long-term
bond yields are at 45-year lows. These tried-and-true inflation
indicators are saying: “No inflation.”
So why do
we need more Fed rate hikes?
jobs report for April, with 274,000 new business payrolls and
an upward-revision of 93,000 for February and March, virtually
assures that economic growth for the first half of 2005 will come
in around 4 percent. The tax-cut led economy continues to be stronger
than mainstream economists and the media would have us believe.
But will the Fed attempt to limit this growth, as it has so often
in the past, with its flawed economic models that mistakenly assume
that more growth and more jobs are the cause of inflation? After
all, how can more people working and producing cause inflation?
taught us that inflation is a monetary problem caused by too much
money chasing too few goods. However, as supply-side tax cuts
expand the workforce, production, and investment, the increase
in goods absorbs the existing money supply. Instead of prices
rising, prices fall.
Reserve governors Manley Johnson and Wayne Angell argue that financial
and commodity-market indicators can inform the Fed whether money
is too loose or too tight. Free-market prices, they’re saying,
are smarter than central planners. Right now these market indicators,
like the money-supply figures, are telling the Fed to stop tightening.
a tug of war going on in the stock market today as the bulls and
bears try to figure out which direction the future economy will
Fed itself hold the answer?
Kudlow is a former Reagan economic advisor, a syndicated columnist,
and the co-host of CNBC's Kudlow
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