Wow. Another Paul Krugman post is probably overkill, but I just noticed this paper by Anna Schwartz and Edward Nelson, "The Impact of Milton Friedman on Modern Monetary Economics: Setting the Record Straight on Paul Krugman's "Who Was Milton Friedman?"" cites this blog in the list of references:
Krugman, Paul (2007d). "Supply-Side Economics: Paul Krugman Responds." "Economist's View" web site, April 11. (URL: http://economistsview.typepad.com/economistsview/2007/04/supplyside_econ.html)
That's kind of cool. Here's Brad DeLong's take on the paper and underlying debate over the 'liquidity trap':
Paul Krugman Is Right!, by Paul Krugman: Alex Tabbarrok writes:
Marginal Revolution: Assorted Links: The Impact of Milton Friedman on Modern Monetary Economics. A nice review by Edward Nelson and Anna Schwartz of Friedman's thought and influence over monetary policy that also, in the author's words, sets the record straight on Paul Krugman's 'Who was Milton Friedman'...
I tend to be on Paul's side of this--especially on the issue of the 'liquidity trap'. In a liquidity trap, (a) short-term interest rates are essentially zero and (b) banks have excess reserves. Normally the Federal Reserve changes people's behavior by trading short-term government bonds (which pay interest) for bank reserves (which allow banks to expand their deposits and loans). Fewer government bonds in the economy means more appetite by banks to buy corporate bonds and thus to finance corporate investment. More bank reserves means banks have more freedom to make direct loans as well.
But in a liquidity trap bonds pay no interests, and banks have more than enough reserves to cover their lending to all the borrowers they think are credit worthy. So when the Federal Reserve swaps government bonds for bank reserves it is swapping two assets that are equivalent. Why should this change anybody's behavior? The only reason is that banks think that they might be short of reserves and want more at some unknown point in the future, but can this have a big impact on the economy?
I would say no: that Paul Krugman's approach to the liquidity trap is right.
Paul Krugman on the role of government:
Paul Krugman talks to Mario Cuomo, Guardian Unlimited (Video): ...Cuomo: I've enjoyed reading your book immensely... Let me be sure I have right what I think your basic premise was, ... and that is that the shifting nature of the condition of the American peoples' lives isn't a function of some immutable laws of the market. It's a function more of politics and institutions, etc.
Krugman: Yeah, very much so. ... The middle-class society ... was created. It didn't evolve through the invisible hand. It was created by FDR and the policies of the New Deal. The second Gilded Age we're living in now was created in large part by the policies of Ronald Reagan and other rightwing politicians. ...
...Cuomo: The - maybe this is simplistic, but my favourite historic figure on ideology is Abraham Lincoln, mostly because he was able to reduce everything into little capsules that seemed to make sense, and on the question of ideology, his popular - the most popular quote that I can find is: "Government as the coming together of people to do collectively what they couldn't do as well through the market system privately." And that, it seems to me, is perfect: that if the market works to educate other people or to give them healthcare, then fine. You don't need government, but - [laughs] - it just doesn't work to do those things and so you do need government.
Krugman: Yeah, we don't want government in the business of growing our spinach, because it turns out that's something that farmers, private farmers do a whole lot better. We do kind of want government in the business of making sure that the spinach isn't contaminated with E.coli because that's something that farmers don't do very well...
Cuomo: ...[W]ouldn't ... you have to admit that this country was constructed without the liberal sentiment, because there's nothing in the constitution that says we should be our brother's keeper, and I think really that's why Lincoln preferred the declaration of independence, which introduced the notion of equality in which you could - which fits very nicely where you say in your book that we should have a closer to equal system when it comes to distribution of wealth, et cetera. But the constitution before Roosevelt and before the adoption of all those programs had nothing in it that said you should love one another or take care of one another.
Krugman: Well, it was a different time, you know. That's kind of obvious. But the - again, FDR - talking about him too much, but his - if you look at the speech he gave on the signing of the Social Security Act, he talks at some length about how the conditions of a modern industrial nation create new forms of risk, new forms of uncertainty, and it is the necessary role of government to mitigate those risks.
So, true, when Thomas Jefferson was talking about America, it was - leaving aside the slaves, it was a society for the most part of small landowners, and you probably didn't need social security in that society, but now, you know, by the time that the New Deal is created, we were a society of large corporations and unstable labour markets for blue collar workers, and we needed those things, and now we need them more than ever.
Cuomo: Well, but could you also say about that that what we didn't have for 150 or 160 years was healthcare or education, and nothing was more obvious than that you needed both those things desperately to build the country.
Krugman: Well, it's actually interesting. America pioneered mass education not so much from the federal level, but the idea that every child should receive education; that everyone in the country should be literate is something that started here long before it reached Britain.
Cuomo: You know, it started late in this country, didn't it? It wasn't in the constitution. President Lincoln talked about it a little bit in 1865 and did something - Adam Smith mentioned it as one of the things you'd have to do through a government, I think, and even before that in The Theory of Moral Sentiments for his second book, he said it more clearly, but that didn't happen for a long, long time.
Krugman: Right. But we were the first to - really the first nation to make a point of ... universal education - I mean, I like to say if universal education didn't exist in this country, people on the right would denounce it as un-American, and it's only because it's already in place that they can't quite do that... The case for every child having access to healthcare is absolutely the same as the case for every child having access to elementary school. ...
Paul Krugman on Bill Clinton:
Paul Krugman talks to Mario Cuomo, Guardian Unlimited (Video): ...Cuomo: ...Now, when it came to Bill Clinton -and you certainly you know him well and know his work well. And I think you said in the book at one point that he didn't have any real strong liberal credentials, nor certainly conservative credentials. You couldn't label him as either.
Krugman: Well, you know, I was - I mean, clearly his values I would have described as liberal, but he didn't come into the strong view about exactly what the role of government should be. I don't know what you think; I think of it as a liability. I think in the end - not so much him. It's not a critique of him. I think that we did not have a well-defined progressive movement when he came into office, and that that was a great handicap - that the other side knew what they wanted and the people who voted for and supported Bill Clinton were not so clear on what they wanted and he didn't have a clear agenda as a result.
Cuomo: Yeah, and you made that point in the book that he didn't have an agenda and therefore he didn't leave a legacy, really. And I think you're right about that. But most people - I'm not sure you did - but most people, I think, would say he had a good record.
Krugman: Oh, he ... did a terrific job of governing, and you know, ...when Bush came to the White House, we forgot how important it is simply to take the business, to take the job of running the US government seriously. So you look at - Fema was a prized, a much-honoured agency under Clinton - fell apart. The veterans administration was a morass when he came to office - became the best healthcare system in America. ... I want that competence back, but I think we also need to have a clear direction.
Cuomo: See, that puts us in an interesting position. If we admit that he was competent and had a good record - and he had a very good record, he left us with a $5.4 trillion potential surplus - but that, you know, there was internet and globalisation, a lot of other things came to his aid, so there was coincidence working there. But if you assume, OK, he's not a real liberal. He wasn't markedly liberal or markedly conservative, and he winds up in good record, why don't we look for another such person now in 2008? Why should we look for a liberal?
Krugman: Well, partly because there was undone business. In fact, Clinton did fail to get us a universal healthcare system and that's terribly important and that was a huge missed opportunity. ...
And also some of his achievements, it turned out, were squandered. Wouldn't we rather that Bill Clinton had managed to put in place some new institutions that would make America a better place rather than pay off a lot of debt so that George Bush could come in and run it up again?
I mean, in some sense, you want a more enduring legacy because you want something that will persist. The great thing - again, I'm going to go into my FDR worship again - but the great thing about FDR is he created institutions - social security, unemployment insurance, minimum wages - that all survived till this day despite the assaults of people who wished that it had never happened.
Paul Krugman on inequality:
Paul Krugman talks to Mario Cuomo, Guardian Unlimited (Video): Cuomo: What I want to ask you next is to get to equality... Warren Buffet says there's a class warfare and the rich are winning. I think that's a pretty good description, don't you?
Krugman: People like me call it a second Gilded Age. That's not a bad of exaggeration of that. It's really true by the numbers. You go to Greenwich, Connecticut, and where all the great gilded mansions are and these days, hedge fund managers are buying up those mansions and tearing them down to build stuff that's bigger. So we really are in the second Gilded Age.
Cuomo: I'm going to ask you the practical question now that the voters really should be asking: How do we deal with it? What do we have to do to get more equality here without being considered communists or rabid socialists? What are we doing about - talk about trade policies and education and the question of the Chinese currency, what specific thing do we have to do?
Krugman: OK. Let me say I don't think that the - I don't think the charge of being socialist or communist works as well as it used to.
There is a problem. Americans think they don't like government programmemes, but they actually like the ones they have. ...
The other things - the policies that led to the explosion of inequality were not any one thing. It was just a systematic bias in policies across the board, and resolving it is - tilt the balance back the other way: everything from expanding the Earned Income Tax Credit; more financial support for lower-income students in college. We're becoming the shame of the western world on that in that respect. Higher minimum wages; labour laws that make it easier for unions to organise and much harder for employers to get engaged in union-busting.
You can think of a number of other policies, none of which is actually qualitatively different from things that we already have on the books, but larger quantitatively and I think the combined effect is in fact qualitative - that really do get a significant movement towards greater equality, just as the cumulative effect of the nickel and dime-ing those policies down, under conservatives, led to a great increase in inequality.
Cuomo: I was interested especially in education, where I think it's very possible for people to say, look, one out of four of our workers are high-skilled, which is roughly four years after high school, and that's one of the big problems. This is a high-skill society, etc, etc, and you don't eliminate that as - of course, but then you diminished it a bit and are maybe saying too much about skill level and education.
Krugman: Yeah, by all means. But the huge increase in income gaps has occurred actually within people with a college education or equivalent. The high school teachers and hedge fund managers tend to have roughly similar levels of education actually, but the highest paid hedge fund manager in America was paid enough last year to pay the salaries of all 80,000 New York school teachers for five years. [Laughs] So that's telling you something about where we really are. ...
Paul Krugman on international trade and inequality:
Paul Krugman talks to Mario Cuomo, Guardian Unlimited (Video): ...Cuomo: How about trade policies, and what level does that play in inequality? And if you talk about trade - please talk, too, about evaluation of currencies and China.
Krugman: OK. Trade is a fairly agonising issue. I will - you know, I've been pretty much a free trader, though not, I think, for the standard reasons. And I'm in favour of it because it's so important to the world's poorest countries. The access to world markets is really the only hope they have of escaping from the direst of poverty.
Now, that said, does trade have an unequalising effect within the US? Yeah, it does. It's probably not the dominant factor in our rising inequality by a long shot. It does not explain the gap between hedge fund managers and high school teachers, but it does somewhat widen the skill differential. The problem is if you just start randomly protecting, then you're going to disrupt this world economy, which is so important.
The point I would make is that the same forces of globalisation that affect the United States affect every advanced country, and yet the collapse of the middle class, the emergence of a new plutocracy is unique to the United States. We can look at Canada, France, Sweden, and see that those countries can cope with global markets while maintaining a decent standard of living for their workers, so can we.
Cuomo: Global union movement, I guess, being diminished as it has been, hasn't helped any on that.
Krugman: Oh, it's enormously important. The collapse of unions, which is not - not an invisible hand phenomenon. It's - I have a comparison in Conscience of a Liberal between Canada and the United States. We had similar rates of unionisation in 1960. We both had around 30% of workers in unions. Canada is still almost as unionised as it was in the 1960s. In the United States, the union movement is a shadow of its former self and that's because the legal environment, essentially - well, Reagan declared open season on union-busting, and there's every reason to believe that strong unions are an important counterweight to the power of employers, not just directly in wage negotiations, but in everything from the setting of CEO salaries to the setting of the political agenda.
Cuomo: [We] tried to get closer to a equitable sharing of wealth is a progressive income tax system, and it seems to me that the public is easily confused about taxes. For a while in the Reagan years, they were convinced that any tax cut was good and any tax increase was bad, and they still believe - most people - that Reagan was a tremendous tax cutter, which he was with the marginal rate, but he raised taxes seven times after that.
Krugman: Right. And he cut income tax rates, but raised payroll taxes and 86% of working Americans pay more payroll taxes than income taxes. So, by and large, if you were a middle-income working American, Reagan had actually raised your taxes. ...
Cuomo: What has impressed me for a long time and I use it sometimes in debates: Reagan raised about $99bn in taxes. Putting aside social security, which he also raised, then Bush Sr had to raise taxes about $90bn because the deficit was so great and the debt was mounting as a result of the tax cuts and the heavy spending on the military by Reagan, and so that's two big tax increases.
Then Bob Rubin convinces President Clinton to start with a big tax increase, all of them at the top, and that was followed by the four best market years in history, 22m new jobs and a $5.4trillion surplus. Can't we argue that at the very least, taxing the super rich is not going to be bad for the country?
Krugman: Oh, look, the postwar generation, going back a bit further, you know, back when we had that socialist Dwight Eisenhower running America, the top tax rate was 91% and that - the 25 years after second world war were the best economy America has ever had.
Cuomo: Also, he's another good illustration, I think - I hope you'll agree - that government is a good thing and a necessary thing and a vital thing. His highway programme was a vital contribution to our progress through an improved economy. Isn't that the case?
Krugman: Yeah, of course. That is an enormous example. Without government action, we'd be fighting stop lights coast to coast, and we'd be a much less productive economy. There are some other areas where I wished we could do the same. In a way, we need an interstate highway programme for broadband internet, and we're not getting it. ...
Paul Krugman on Iraq:
Paul Krugman talks to Mario Cuomo, Guardian Unlimited (Video): ...Cuomo: Of course your book does deal with Iraq, and that is a subject that divides liberals and conservatives. You believe that 2006 was a big victory for the Democrats, but in describing the reasons for the win, beginning with chapter 10, you never mentioned our implicit promise to get the troops home. Now, wasn't that a major reason why they voted for us in 2006, and isn't one of the Democratic problems now - a substantial one - that you were heard to say that you were going to bring them home and you failed. Now, the fault is maybe the Republicans for stopping you, but isn't that a problem for us going into the presidential election?
Krugman: It's a problem for mobilisation. It's not a problem - nobody is going to vote Republican because the Democrats failed to get us out of Iraq. I can't imagine that, but maybe some people will be less enthusiastic in putting their energies into the campaign.
It's a problem. It's - I'm simultaneously, like, I think everybody who hates this war, I'm simultaneously frustrated, angry, annoyed with the Democrats for wimping out and yet I can see their... it's very hard. They have no way to do this except to refuse to vote the funds, and that's a very risky thing to do, and because they have such an overwhelming advantage on domestic issues, their natural inclination - and it may even be the right thing to do - is to basically keep possession of the ball and not risk it on a confrontation.
But it's a terrible thing because in this period, this interregnum, we're going to have spent at least $200bn on the war, we're going to have lost the lives of at least 1,000 Americans in Iraq, and you know, that's continued. It's a terrible thing. But I don't know. I don't have a clear sense of what I would do if I were Nancy Pelosi right now.
Cuomo: I think the other thing that I'd suggest, for whatever it's worth, I'd like your comment. I think the big mistake was made in 2002 when Congress ignored the constitution and sought to delegate their singular obligation to be the ones that declare war - delegate it to the president by signing these resolutions that said in effect we're not going to declare a war. It's all right if you do, we'll leave it up to you, and then gave him some instructions.
Now, that was a mistake and it was unconstitutional. And one of the things that Democrats might do now is admit that and say we're not going to let it happen again, especially not with respect to Iran, which appears to be getting to be an issue. How do you feel about that?
Krugman: Yeah, well, certainly they should - and that's - that is no excuse, for not having a clear declaration that it's not OK to attack Iran. If there's one thing I hope we've learned, it is that you cannot trust this administration to be at all rational. It's clear that bombing Iran would be catastrophic, but it's not clear that reality penetrates into that bubble, and I am very afraid that they may go ahead and do that.
Cuomo: ...One thing that boggles the mind of most simple people like myself who look at this situation is how do you explain that - now the last number I saw was $600bn already spent on Iraq - $600bn. The second world war, $3trillion. They were in Depression and they spent $3trillion.
Now, you spend $600 billion, you're on your way to a trillion, a trillion dollars. How is it that you don't have enough money for healthcare, for education, for tax cuts for the middle class, if you can produce the money - and we always do - for war or a calamity of any kind? Is it as simple as you're using a machine to make dollar bills and just put them out there and hope that there's not inflation? How does that happen that you have all that money, but can still make a plausible argument that we can't afford to do these other good things?
Krugman: Oh, you can't actually. You can't. The money is being borrowed. We're actually not using the printing press, you know, the rate at which money is being printed has not gone up. It's all being borrowed. It's being borrowed, ultimately, largely from the Chinese and from the Middle Eastern oil exporters. So, ultimately the paymasters for this war are countries that [laughs] aren't actually on our side in other respects.
But there's no plausible case. A dollar spent is a dollar spent, but that comes back to what we were saying earlier: that the reason Bush doesn't want to spend money on children's healthcare, doesn't want to provide more for education, is not because the money isn't available, but because he's ideologically opposed to it. He does not want to establish the principle that children are entitled to healthcare. He does not want to establish the principle that bright kids from poor families are entitled to be able to go through college. That is the - it's not the - the sums are trivial. The whole SCHIP that was - 41 days in Iraq will pay for SCHIP for five years, so it's ridiculous.
Cuomo: People like Pete Peterson, the former secretary of commerce and Blackstone and titan of Wall Street, etc, has been writing books for years about the debt and deficit. And he's very gloomy about the prospects of what that will do to us cumulatively. You don't seem to share his degree of concern or did I misread you?
Krugman: I don't share that degree of concern because those gloomy projections you look at are driven by the rising cost of social security, medicare and medicaid. Well, there is no programme called social security, medicare and medicaid. Social Security is driven by an ageing population, and it's a modest size problem - not trivial, but it's modest size. It doesn't worry me that much.
Medicare and medicaid are healthcare problems. What drives it is healthcare costs, and we need to do something about healthcare costs in any case for the private -- for the non-medicare and medicaid. If we can cope with healthcare, then the whole entitlements crisis becomes something that's quite manageable.
So, no, when you look at those charts, they show that it's overwhelmingly driven by runaway healthcare spending. It's not about a government that's making too many promises. It's about a healthcare system that is out of control.
Cuomo: I've just about used up my time, and I want to be sure to give you one last opportunity to say anything you want to say that I didn't give you the chance to say so far.
Krugman: You know, maybe - because you've been through a political life and I haven't, but - the astonishing thing to me right now is how optimistic I'm feeling in spite of this terrible war going on, in spite of all the really very bad people still running the US. Three years ago, there was a real sense, I think, of despair about where this country was heading and now you can just see the American people are better than the pessimists had it. The system, I think, is more durable. So, hey, we may be about to turn this whole thing around.
Cuomo: I want to tell you, you know, Paul Krugman, The Conscience of the Liberal - your conscience is clear indeed. It is. [Laughter]
Jonathan Chait looks at Rudy Giuliani's economic policies and his ideas about freedom:
Economaniac, by Jonathan Chait, The New Republic: ...Compared to other Republican presidential contenders, Giuliani identifies himself as a "supply-sider" ... more aggressively and has mopped up more financial support from oil, gas, and other bastions of the financial right. But economic right-wingery has conquered the GOP so thoroughly that there's not much Giuliani can do to stand out, platform-wise. What truly sets him apart is the apparent depth of his convictions, and the extent to which he is willing to follow the right's philosophical premises through to their grim conclusion.
Consider Giuliani's position on health care reform. ... Like many Republicans, Giuliani's proposed health care reform is to provide a tax deduction for individual health care. Of course, the value of a tax deduction is proportionate to your income... If you don't earn enough to owe income taxes, or if you have a pre-existing condition and can't afford coverage, a tax deduction would probably be worthless. Giuliani's tax deduction remedy would therefore do virtually nothing to cover the uninsured. ...
Giuliani ... is not indifferent to the plight of the uninsured. He actually seems to revel in it:
I don't like mandating health care ... because it erodes what makes health care work in this country--the free market, the profit motive. A mandate takes choice... We've got to let people make choices. We've got to let them take the risk--do they want to be covered? Do they want health insurance? Because, ultimately, if they don't, well, then, they may not be taken care of.
...Of course, this analysis is insane, unless you think most of the uninsured lack coverage because they'd rather splurge at Best Buy than spend money on health insurance. Alas, this appears to be exactly what Giuliani believes. "[The uninsured] may be buying a television, ... they may be buying a cell phone," he said at last week's debate. ...
Giuliani's extreme ... economic right-wingery seems to flow from a deep-seated punitive impulse, which he has transferred from the shiftless New York City underclass to vast swaths of the population. Giuliani has echoed the language of economic libertarianism with more frankness, and less pretense of compassion, than any recent Republican presidential candidate. ...
Giuliani, of course, is careful not to antagonize social conservatives. But his campaign is in fact an attempt to define social conservatism out of the Republican platform. While most Republicans define their party's values by invoking three parts--small government, strong military, social conservatism-- Giuliani only mentions the first two. A recent editorial in the pro-Giuliani New York Sun proposed a list of GOP values. Item one was a belief that tax cuts make revenues rise. Social issues did not make the list at all. Last winter, Giuliani told a crowd at the Hoover Institution that the GOP must redefine itself around economic issues--health care, school choice, taxes--as the "Party of Freedom."
Of course, Giuliani's vision of "freedom" is not necessarily about liberating the human spirit. "[F]reedom is not a concept in which people can do anything they want, be anything they can be," he once explained as mayor. "Freedom is about authority." ...
You can't be all you can be? Dang, I was counting on that. I remember hearing somewhere - I think it was from some freedom protection organization - that you could.
Tim makes a bold call on the outcome of the Fed's rate setting meeting:
And So It Begins, by Tim Duy: The Fed begins a two-day meeting today, with market participants widely expecting a rate cut. I am mentally prepared to be on the wrong side of this call, joining the lonely few, but I just can't tease another rate cut out of the incoming data.
In my mind, the argument for a rate cut hinges on one crucial assumption – that the market is expecting a rate cut, and the Fed will not want to disappoint. From Bloomberg:
''The Fed is reluctant to ease,'' says Louis Crandall, chief economist at Jersey City, New Jersey-based Wrightson ICAP LLC, a unit of ICAP Plc, the world's largest broker for banks and other financial institutions. ''But it also doesn't want to unsettle the financial markets unnecessarily.''
If the Fed fails to ease, so the story goes, they will be blamed for failure to communicate effectively. After all, given their push for transparency, shouldn't they make an effort to send a signal when the markets are headed in the wrong direction? The problem with this view is that Fed Chairman Ben Bernanke does not believe it is his job to lead markets around by the nose like his predecessor. I think under the new regime, the Fed expects their comments to be taken at face value. And I think they are pretty effectively communicating their view on the economy: Outside of housing, there is minimal spillover, and whatever spillover exists is completely expected. From Bernanke on October 15 (italics mine):
Since the September meeting, the incoming data have borne out the Committee's expectations of further weakening in the housing market, as sales have fallen further and new residential construction has continued to decline rapidly. The further contraction in housing is likely to be a significant drag on growth in the current quarter and through early next year. However, it remains too early to assess the extent to which household and business spending will be affected by the weakness in housing and the tightening in credit conditions. We will be following indicators of household and business spending closely as we update our outlook for near-term growth. The evolution of employment and labor income also will bear watching, as gains in real income support consumer spending even if the weakness in house prices adversely affects homeowners' equity. The labor market has shown some signs of cooling, but these are quite tentative so far, and real income is still growing at a solid pace.
A week later, Chicago Fed President Charles Evans reiterated the outlook:
Indeed, on balance, I would characterize the data we have received on the real economy since the last FOMC meeting as supporting our baseline forecast.
Such comments – that the economy is roughly in-line with the Fed's forecast – are essentially ignored by commentators. Has anyone noticed that the data flow has steadily caused 3Q07 estimates of growth to be raised above 3%? Think about it – the Fed cut rates 50bp during a quarter in which growth topped 3%, just after a quarter with almost 4% growth.
The Fed is never that proactive. Never.
Yes, I know, forecasts for 4Q07 are low on the potential impact of the August market turmoil. But note that we have almost no data on the 4th quarter to assess the quality of those forecasts; largely some volatile data on consumer confidence and jobless claims. Moreover, the Fed expects weakness, and is trying to look through it to mid-2008. And the Fed already cut 50bp because they knew that they would not have any good data on which to assess the 4th quarter at their October meeting. Nor would they normally commit to policy with only a single month's data. The month is not even over! That was the "risk management" portion of their decision to cut 50bp in September. How many rate cuts do you take as insurance?
And, on risk management, Fed Governor Frederick Mishkin, one of the architects of 50bp move, sees financial conditions improving:
''Market functioning has certainly not yet returned to normal,'' Mishkin said in a speech at a seminar commemorating the 1907 U.S. financial panic, which led to the Fed's creation. Still, Fed actions ''have helped improve conditions in several short-term funding markets and instill confidence in investors that liquidity would be available if needed,'' he said.
They did not expect conditions to return to normal overnight; they are simply looking for things to be moving in the right direction. And they are – notice that the ABX market is coming unglued again, as documented by Calculated Risk, but the impact on financial markets is considerably more muted than this summer.
I also believe that this latest jump in oil prices will cause Fed policymakers to question their confidence in the inflation outlook more so than the growth outlook (if economic activity was really coming unglued, oil consumption should be slowing). And notice that despite a softer near term outlook for the economy, FedEx is still prepared to boost its air rates 6.9% next year, following this year's 5.5%. They must be pretty confident of their pricing power. In my mind, the entire commodity complex is a worrying signal about the path of inflation, but I doubt the Fed is as concerned. Likewise the Dollar; I still have trouble believing the Fed has completely written off the Dollar, but continued rate cuts would signal that the Greenback remains a one-way bet.
Finally, I think analogies to the 1998 rate cuts are missing a key ingredient. Then, the world economy was teetering on the verge of collapse (perhaps a bit melodramatic, but you get the idea). Today, the global economy is in the completely opposite condition, this time dragging the US along and helping to offset a portion of housing weakness.
If the Fed decides they are unwilling to defy the market, or that "risk management" requires additional rate cuts, I would have to conclude that regardless of what the statement says, that one must expect a series of multiple rate cuts. They will be responding to the deteriorating housing market, and I simply expect no stabilization in that market in the near future (don't get me wrong – I am not a pie-in-the-sky optimist).
Finally, if they do cut, I wish they would stop telling us that their forecast is for moderate growth near potential. A rate cut would suggest that they clearly do no believe that forecast.
Bottom Line: I believe the Fed intended to take a pass in October with the 50bp rate cut. I believe market participants were correctly reading the data until they got caught up in the risk management story. I think the Fed has been explaining past actions, not future policy. For that, you need to look at their forecast. On the basis on the data alone, the Fed is already so far in front of the curve it is hard to justify another cut at this point. I absolutely do not expect the Fed to cut 50bp.
This is the most contrarian call I have made; I simply believe that the case for a rate cut is much weaker than market participants appear to believe.
Update: Here's Greg Ip in the Wall Street Journal:
Why Rate Cut Isn't a Sure Thing, by Greg Ip, WSJ: The market is convinced the Federal Reserve will cut interest rates tomorrow, but for the Fed itself, it is a closer call. ...[F]or policy makers, the decision is between the quarter-point reduction and no cut at all. A half-point cut is unlikely to get serious consideration...
Both courses of action have risks. Perhaps the biggest is that the market's certainty that rates will be cut creates a burden on the Fed to deliver. Ordinarily, meeting market expectations isn't a goal in itself for the Fed. But the current environment is more fragile than usual...
The Fed can mitigate the risks on either front with its accompanying statement. No rate cut could be accompanied by a statement opening the door to a future cut. A cut could be accompanied by a statement damping expectations of more reductions. ...
The case for remaining on hold comes down to the economic forecast. While housing data has deteriorated further, there is little sign so far that it has spilled over to the broader economy. Fed officials don't appear to have significantly altered their forecast of a return to moderate growth next year. ...
[T]he biggest argument for cutting rates will be market expectations. Fed officials didn't intend to nudge the market to expect a rate cut, so they will have to weigh the possibility that markets are signaling a more pessimistic view on growth and credit markets than the Fed sees. ...
Update: The Chicago Board of Trade's CME Group Fed Watch has:
Summary Table October 24: 86% for -25 bps versus 14% for -50 bps. October 25: 86% for -25 bps versus 14% for -50 bps. October 26: 92% for -25 bps versus 8% for -50 bps. October 29: 2% for No Change versus 98% for -25 bps. October 30: October 31: FOMC decision on federal funds target rate.
A graph of the probabilities from the Cleveland Fed is here.
Hi. We're from the government, and we don't want to help:
Bigger Budget? No, Responds Safety Agency, by Stephen Labaton, NY Times: The nation's top official for consumer product safety has asked Congress in recent days to reject legislation intended to strengthen the agency, which polices thousands of consumer goods, from toys to tools.
On the eve of an important Senate committee meeting to consider the legislation, Nancy A. Nord, the acting chairwoman of the Consumer Product Safety Commission, has asked lawmakers in two letters not to approve the bulk of legislation that would increase the agency's authority, double its budget and sharply increase its dwindling staff.
Ms. Nord opposes provisions that would increase the maximum penalties for safety violations and make it easier for the government to make public reports of faulty products, protect industry whistle-blowers and prosecute executives of companies that willfully violate laws.
The measure is an effort to buttress an agency that has been under siege because of a raft of tainted and dangerous products manufactured both domestically and abroad. ...
Ms. Nord's opposition to important elements of the legislation is consistent with the broadly deregulatory approach of the Bush administration... Tony Fratto, a White House spokesman, said that Ms. Nord had not coordinated her effort to kill the legislation with the White House. But he said that the administration shared many of her concerns and that Allan Hubbard, President Bush's top economic adviser..., was preparing to send a letter to Congress "that is probably even more forceful than Ms. Nord's." ...
Ms. Nord, who before joining the agency had been a lawyer at Eastman Kodak and an official at the United States Chamber of Commerce, criticized the measure... Some of Ms. Nord's complaints were similar to the ones that business groups and manufacturers have raised, including that the legislation would be unnecessarily burdensome. But in other areas, like whistle-blower protection, her complaints went beyond those of industry. ...
Consumer advocates also said they were stunned by the letter. ...
The agency has suffered from a steady decline in its budget and staffing in recent years. Its staff numbers about 420, about half its size in the 1980s. It has only one full-time employee to test toys. And 15 inspectors are assigned to police all imports of consumer products under the agency's supervision...