January 30, 2008
But then I wake up…
And a rude awakening it has been.
The Fed cut the target for the Federal Funds rate again, this time by 50 basis points. The data released earlier today confirm that the Fed has given up on inflation control: headline CPI inflation was still humming along at 4.1 percent year-on-year in December 2007. Even the misleading ‘core’ inflation indicator favoured, for no good economic or statistical reason, by the Fed registered a 2.7 percent increase.
Much was made in the media of the fact that real GDP growth for Q4, 2007 was only 0.6 percent, the lowest quarterly increase since 2002. This (in my view erratically) low figure should be juxtaposed, however, to the (in my view equally erratically) high figure of 4.9 percent in Q3. The markets had been expecting 1.2 percent for Q4. Looking slightly further ahead than the length of the median FOMC member’s nose would have revealed that inventory decumulation reduced GDP growth by 1.3 percentage points in Q4. This reduces expectations of further inventory disinvestment and is a positive for future GDP growth.
The payroll data were much stronger than expected, with 130,000 jobs added (against market expectations of a gain of 40,000). Together with the buoyant durable goods orders data a few days ago, the balance of the recent real economy information has been stronger than expected. Inflation data have come in both rising and higher than expected.
So what possesses the Fed? Has it become a single mandate central bank, with just the maximisation of short-run real growth and employment, regardless of their sustainability, as its objective?
By now, the neglect by the Fed of the price stability leg of its mandate no longer comes as a surprise. But even fully anticipated mistakes hurt. The US and the world economy will pay the price when, in due course, the Fed has to clean up the mess it is creating by its reckless pursuit of the maximum employment objective.
Is it possible that the Fed is in panic mode about the solvency of the real banking system? So they cut the short-term rate to bolster bank earnings for a few quarters hoping they can outrun the write-downs on rapidly-depreciating assets?
I am trying to imagine any other rationale for 125 bps in one week, especially given the moderate economic data and rising inflation measures…
Posted by: Nemo | January 30th, 2008 at 9:35 pm | Report this commentThis is not going to win you an invite to the Fed next symposium but it is very funny. You are lucky you don’t have to put up with the herds screaming that the sky is falling!
Posted by: domi | January 30th, 2008 at 11:21 pm | Report this comment“reckless pursuit of the maximum employment objective”
Mr. Buiter, would you be willing to entertain the notion that the Fed’s real objective has been boosting the stock market? The thought has certainly crossed my mind.
Posted by: Mr. Noah | January 31st, 2008 at 12:45 am | Report this comment“reckless pursuit of the maximum employment objective” - you must be joking. The pursuit is the avoidance of the maximum financial institution collapse. Isn’t it better to err on the side of over-easing then to roll the dice with the risk of enormous financial catastrophe, that at the end of the day the governement would have to bail out anyway (at substantially higher costs).
Posted by: Paul | January 31st, 2008 at 3:55 am | Report this commentMr Buiter
I do not follow your argument that the FED stopped looking at inflation. If the Fed expects a recession, it would not see the current interest rate cut as inflationary. In a few months time, and therefore, today, given the policy lags, the Fed problem may turn out to be deflation. Current data on prices or employment in the recent past, which you refer to, do not give much information about where the economy will be at the end of the year. The stock market falls, the huge write-downs taken by many financial companies, the downgrading of bond insurers, may be a better indication of that.
Posted by: Pierre | January 31st, 2008 at 4:28 am | Report this commentDear Mr Buiter,
Posted by: Shane Jak | January 31st, 2008 at 5:49 am | Report this commentSir, I seem to remember years ago reading that the Feds job was also to make sure that no economic crises happened during an election year, to not influence voters against the party in power. Given your thoughts on their (which seem to be shared by many others), then maybe the motivation is political. If the above is true, then trying to apply logic to the Feds actions is a useless exercise. Hence, applying reason, logic and experienced judgement may be the fatal flaw in your thinking??
Am I wrong in thinking that “knee jerk” has applied to 2008 Fed actions, rather than 2007 actions? Maybe Jan 1 was the start of their shift to a political mandate.
Also, assuming that this house of cards can be propped up during 2008, then post elections 2009 may be when the cards fall where they may. But if the Fed is going to react like it has so far in 2008, then a few more small bad news shocks will either leave the Fed without more tools to apply or their irrational use of these measures will cause the very finacial crisis that their political mandate requires them to avoid.
My personal belief is that many hard working, ordinary, good folk around the world may eventually suffer badly because of a combination of US political imperatives, the greed of US and other financial institutions (e.g. non transparent, unintelligible, synthetic financial instruments) and banks and others of their ilk taking advantage of the fact that they cannot be allowed to fail - which encourages greedy risk taking.
Like you say, its time to get out of town.
Yours faithfully,
Shane
p.s. please forgive the roten speling, bad grammars and poor pun,ctuation.
Bond insurers are in crisis. There is 1 trillion in US credit card debt alone. The credit bubble has reached staggering proportions and is slowly unwinding. The Fed is desparately trying to avert a collapse of the world financial system (I remind you of the massive ECB bailout before the end of last year), and we have smug academics sitting back and taking potshots. How nice it must be to have tenure and be able to fiddle while Rome burns.
Posted by: joe | January 31st, 2008 at 6:25 am | Report this commentI remember that when the Q3 GDP was released, some (Roubini?) pointed to the large growth in inventories as a negative for Q4. That’s now happened. But one cannot automatically extrapolate and argue that the Q4 drop in inventories is “a positive for future GDP growth”, at least not in the short-run. If businesses anticipates slowing demand (as the latest survey of US CFOs suggests), they will keep inventories low or even continue to destock.
Posted by: Carlomagno | January 31st, 2008 at 10:42 am | Report this commentAs for the ADP payroll number, I’ve seen conflicing accounts of this: is it based on “real” jobs only or do they adjust like the BLS establishment survey (birth/death model)? If it’s the latter, ADP’s numbers are likely to significantly flatter the actual employment trend.
Posted by: Carlomagno | January 31st, 2008 at 10:54 am | Report this commentShane,
The political mandate of which you speak does not exist and asserting it checks you into the tin foil hat hotel. Did you read that on Hugo Chavez’s blog? Even in the impossible event it is true, the leading candidates of the incumbent party are going out of their way to avoid being seen or connected to the president so the fed would probably weight the importance of such activity significantly lower than other factors in their decision. That banks are taking advantage of the fact they will not be allowed to fail is true though we won’t have to witness anything close to a failure given the feds willingness to “make it rain”.
Posted by: Thomas | January 31st, 2008 at 6:59 pm | Report this commentThomas,
Posted by: Shane jak | February 1st, 2008 at 8:21 am | Report this commentTry research Presidential Election Cycle Theory, e.g. the Book; TRADING THE FOUR-YEAR PRESIDENTIAL ELECTION YEAR CYCLE
From Frank Taucher, publisher of The $upertrader’s Almanac, comes this very timely volume. Review Quote’ “Taucher explains that this reference work has been constructed to provide the reader with the same edge that those who study the effect of the Presidential cycle on the stock market have. Taucher goes on to explain: “The assumption is that politicians and monetary authorities conspire to inflate the economy and increase prosperity to the greatest extent possible during the year preceding and containing the election. After the election, the Federal Reserve Board then again concentrates on fighting inflation the previous monetary binge has caused, politicians enact tax hikes, etc., and the stock market corrects, followed by a declining economy.”
Tom; “Tin Hat Hotel”? Quite a novel insult really, if a bit obscure. I had a good laugh. Please go one better to this reply. I hope all your teeth fall out, except 1 and then you get toothache.
Although I agree there is a huge risk of inflation but would we want to risk deflation?
In my view it is clear that the Fed provided way too much liquidity until recently, as evidenced by ballooning commodity prices, esp gold. They in fact provided so much liquidity that banks started lending money to people who had no intention of repaying, effectively lending at highly negative interest rates.
Why did the Fed wait so long to reverse itself? Did they focus too much on the meaningless core inflation number and ignore the warning bells in the commodity markets?
Of course they had to stop at some point. Inevitably the end proved to be messy. House prices dropped, subsequent solvency fears caused banks to panic and and drain liquidity from the market. Now the Fed is reversing itself once more and desperately trying to re-inject liquidity before the situation spirals out of control and we find ourselves in full Japan mode.
Normally I agree with Buiter, not this time. It is a mess, but at this point the Fed has no choice.
Posted by: Joes Leopold | February 1st, 2008 at 3:09 pm | Report this commentI’m beginning to think that the Fed are taking the view that what they might consider to be a ‘bit of inflation’ is the answer to the finacial meltdown we are quite possibly facing. If the Bank of England cuts rates too then they will likely be thinking the same. An article in figurewizard.com: House Prices - Crash or Correction? makes the point that the secondary banking crash of 1973/74 was followed by 16% inflation in 1974 and 24% and again 16% in the two years that followed. This effectively slashed the value of mortgage debt by more than half. Seeing as the stalled housing market is what has underpinned the economic boom of the last seven years, could this be their what’s exercising their minds now?
Posted by: figurewizard | February 3rd, 2008 at 10:20 am | Report this commentWillem, Under Greenspan, the FED became captive to the wall st supply-siders. Bernanke, as the balance sheet “director” through the financial accelerator model is trapped by the ongoing debt deflation and it’s financial braking results.
Bernanke probably feels that he must put a floor under housing no matter what or a repeat of Japan is all but certain.
A fat spread for the banks seems to be on his agenda as well.
Posted by: groucho | February 4th, 2008 at 4:04 pm | Report this comment“The US and the world economy will pay the price when, in due course, the Fed has to clean up the mess it is creating”
Willem, what if it turns out that both Greenspan and now Bernanke are the CB equivalent of “FIREFIGHTER ARSONISTS”?
Also, should they be given medals when they “save the world”?
Posted by: groucho | February 5th, 2008 at 11:43 am | Report this commentThomas Palley published an essay in the Guardian suggesting that growth is now only achievable through monetary inflation and asset price rises as the manufacturing model of growth has been exported to LDCs
Looking at the recent exponential ascent of house prices in the UK it looks as if this had reached a stall and one wonders if it just falls back to earth….causing a lot of problems in the process.
However the Treasuries (UK & US) should be buying in alll those Long dated securities that they sold in better times to control monetary inflation ……..Oh they didn’t?
Posted by: Damian | February 10th, 2008 at 9:15 pm | Report this comment