The Economist Backs Fed Rate Cut

There is nothing I suppose unusual in this. What is more interesting is that they cite the Fed's own paper to prod the Fed. Equally you could cite the Economist's own euro arguments (see two posts down) to say that dropping the dollar another 5% could give a lot more stimulus. Alan Greenspan's job is to play poker, and at the level of to cut, or not to cut another quarter point I guess he's better placed than I am. There is no clear 'good' decision available here. My feeling is that the closer we get to zero the more people will get nervous and that this factor can offset any beneficial effect. One rather worrying detail here is the way everyone is quoting the 'Ahearne et al' Fed paper, as if the mantra would itself ward-off any looming deflation. (Really the arguments in this paper have received very little critical examination, which is, in-itself, quite disturbing). Anyway, it's your call Alan.

America's Federal Reserve has to make its decision when its open-market committee meets next week. Some economists argue that, since the present weakness in American confidence and spending is largely due to uncertainty about the consequences of a war with Iraq, it might be better to hold fire for now and see what the economy looks like once the conflict is over. If the war goes well and the economy rebounds afterwards, an interest-rate cut may be unnecessary. Even if the economy remains weak, they argue, a rate cut then will be more effective than it would be now, when it is likely to be swamped by dismal headlines about war. With interest rates already as low as 1.25%, the Fed should save its ammunition.

This argument is wrong, for two reasons. First, at a time of heightened uncertainty, it is wiser to take out an insurance policy against a future deep downturn. If a rate cut proves unnecessary, the cost of reversing it would be small. On the other hand, if the American economy remains weak, valuable time will have been gained in giving it an extra boost. When the world economy is groaning with spare capacity, there is little risk that any excessive easing of policy might send prices soaring. A greater risk is of deflation, not inflation. The lesson of Japan's failure to arrest deflation after its bubble burst in the early 1990s is that, as interest rates approach zero and the risk of deflation rises, a central bank should cut rather sooner than it might otherwise. Once deflation sets in, monetary policy can do little to pull an economy out of a slump. A second argument is that today's weak demand is not entirely due to worries about war with Iraq in any case. A large part of it reflects the fact that households and companies are only halfway through purging the excesses of the bubble years. Even without any fallout from a war, the economy is in need of some help.
Source: The Economist
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