In a little while, the Federal Reserve governors will announce their latest decision on interest rates. A while back I kicked up a firestorm here by saying the Fed should have cut interest rates; the next day, a big bank scare in Europe caused a huge credit scare, and the Fed was forced to take all sorts of emergency interim steps to keep credit from drying up… and then it lowered its key rates by a half-point each. So, now, morning reports in the Wash Post say that most Fed watchers both hope and expect that the Fed will cut the rates by another quarter point. So, based on my earlier note, do I now believe the Fed should indeed cut the rates again?
Here is the problem: The price of gold is way up there near record levels. The price of oil is at record levels. The value of the dollar is falling. Psychologically, another move to lower the Fed’s interest rates right now would send a signal that the fight against inflation has been abandoned. That is a dangerous signal to send. We are, for now, out of the crisis situation I accurately described/foresaw last time. It’s time to let the extraordinary medicine of recent months work its way through the system.
What the Fed SHOULD do is this: Keep its rates where they are, but accompany it with a statement that says, basically, that it has already shown an ability to turn on a dime when needed to inject more liquidity into the economy, and that it will keep watching closely in case it needs to do so again… but that it does NOT expect to need to do so, because many underlying measures of economic health remain strong. Its bias going forward (it should say) is to cut rates if needed to avoid a recession, but it is not convinced that such further medicine is needed — and that while overall price inflation remains in check (and there is thus nothing to panic about on that end anyway), it still takes seriously its duty to protect against inflation, so that gives it another reason to stand pat right now.
In other words, it should decline to take any concrete actions, while sending reassuring signals about the state of the economy.
That way, everybody wins. And that way, prudence will be victorious.