Dollars and Jens
Tuesday, January 22, 2008
a quiet day
My brother noticed, before I did, that stock markets around the world spent Monday and Tuesday crashing; I got into work a bit late and was a bit surprised by the media presence around the NYSE this morning, but figured it was probably just normal for the beginning of a trading week and I hadn't really paid close enough attention before. And, you may know, American stocks crashed today, but the fed cut interest rates 75bp this morning, so that the dollar fell only 1% less. (Or you can think of it however makes sense to you; I just happen to have seen charts of exchange rates from when the announcement was made.)

The vote wasn't unanimous; there are two vacancies on the board of governors, and Mishkin was unavailable, leaving 9 voters, one of whom was Bill Poole — I'm pretty sure he's rotating off as a voting member, but that must not take place until next week — who didn't feel a move was necessary a week before a regular meeting. The way that was reported rather makes it look like this cut was in place of a big cut next week, though markets are still pricing in a cut then, too, and the guys at work who get paid to think about these things think they'll get bullied into another 50bp whether that's their current plan or not.

The timing is a bit curious if you're trying to defend the Fed against accusations of placing a "put" on the market — much as Bill Poole seems to have thought — and it might well behoove them to resist bullying next week. Full-scale financial meltdown tends to have less than salutary effects on the real economy, and some response to global financial events was probably appropriate; if this cut was indeed an attempt to shore up the real economy, its timing at least was clearly driven by the markets, and unless next week's data look really, really bad, it's hard to imagine that enough new data will have accrued between meetings to justify 125 bp.

Through the year of the 5.25% fed funds target, I viewed policy as slightly tight, but very close to neutral; I still think neutral is around 4.5%. They're now a full point below that; if you believe inflation is no lower than the optimal rate, and you take the Taylor rule as Taylor introduced it, with coefficients of 0.5, a one percentage point difference between the new target rate and "neutral" would be appropriate for an output gap of 2%. The fed views long-term growth potential as being somewhat below 3%, last I heard; another 50bp tells you that either the fed sees something else recommending a lower rate than I've spelled out — perhaps they have a figure lower than 4.5%, or they think the economy is less responsive to interest rates than Taylor was using, or something else — or the fed thinks we're heading to (or in) recession.

The long end of the bond market, incidentally, saw rates down several basis points, which was a relief to me — and almost certainly to the fed voters as well, who no doubt would have found themselves in a tricky spot if bonds had sold off.

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