On Nov 9, 2007 2:32 PM, Doug Henwood <[EMAIL PROTECTED]> wrote: > > After the Fed's 50 bp rate cut in Sept, BusinessWeek ran an article > > with the memorable title "Fed: Wall Street's bitch." That > > perception has only strengthened since then and now the markets are > > pricing in a near 100% probability of another cut before year-end. > > Not exactly. The markets were very disappointed with Bernanke's > testimony yesterday because he made it sound as if another rate cut > is not imminent. Should things really unwind, they'll undoubtedly > change their mind, but the message they're sending now is no rate > cuts unless the econ data look really bad. Maybe that headline had > something to do with the hard line. > > The Fed's slowness to ease runs counter to the more apocalyptic > reading of the U.S. economy's prospects. >
According to the atimes.com article I linked to, the Fed's slowness to ease may be related to Bernanke's discomfort about the perception that the Fed is a prisoner of the financial markets. Their tough words in recent days may just be an attempt to change this perception, and not related to any specific interpretations of econ data. I find it to be an interesting theory. From what I understand Bernanke's monetary philosophy is based on managing expectations: if the market believes the Fed has inflation under control, it will stay under control in a self-fulfilling prophesy. And he wants to achieve this by setting a numerical CPI target and making everything transparent. The trouble with this self-fulfilling prophesy is the same as with any other virtuous cycle: it can just as easily run in the other direction and turn into a vicious cycle of runaway inflation. Bernanke clearly does not have the required credibility on inflation yet. So can he then afford the transparency? The SF-Fed's conference on "monetary policy, transparency and credibility" indicates there is a lot of disagreement within the Fed itself on this question:* *http://www.frbsf.org/publications/economics/letter/2007/el2007-12.html -------------------------------------------------------snip It is increasingly common for central banks to be transparent about their long-run inflation goals. In addition to democratic accountability, underlying this transparency is the hope that by publicly announcing a target for inflation the central bank will establish more quickly a reputation for price stability and that this reputation will provide a firmer anchor for inflation expectations. By being more open about its goals, procedures, and forecasts, the central bank hopes to convince households and firms that it is committed to price stability, making inflation stabilization less costly. However, even central banks admired for their transparency are not necessarily all that transparent, invariably withholding key information about their policy objectives and their assessment of the economy and its future prospects. Although transparency is generally thought to be a good thing, Cukierman examines the limits of monetary policy transparency, focusing on two main dimensions: feasibility and desirability. With respect to feasibility, Cukierman argues that uncertainty about the economy, about the effects monetary policy has on the economy, and about the measurement of key variables like potential output, the output gap, and the natural rate of unemployment make it extremely difficult for even well-intentioned central banks to be fully transparent. In Cukierman's words, "the 'science of monetary policy' is not yet in a stage at which it can replace the 'art of monetary policy'" (p. 32). With respect to desirability, Cukierman argues that a compelling case for secrecy can be made when the central bank has private information about threats to financial stability, such as about the health of banks. There, too much disclosure may lead to contagion, jeopardizing the wider banking system. -raghu.
