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Quick Take: Can't the Fed Just Lower Rates Already?

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April 02, 2007 – Comments (4)

The original article is here.

One of my favorite aspects of the meetings of the Federal Open Market Committee (FOMC) is the statement it releases when it makes its decisions on interest rate targets. More specifically, I love the way virtually everyone combs over the statement to try to figure out what the FOMC is really saying.

The most recent interest rate decision March 21 was no disappointment. Bernanke & Co. did not use this phrase:

"The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information."

Instead, they opted for:

"Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information."

"Ebullience" may be too strong a word, but the change made investors happy for sure. Why? Well, they assumed that the change in verbiage meant that the Fed is getting ready for a rate cut.

Assume is the key word there. When I was in the seventh grade, I decided not to do my reading for science class one night. The next day, we were given a quiz on the reading, and I blew it big time. When I complained that the teacher hadn't told us that we were going to be quizzed, he replied, "Matt, you assumed that we weren't going to have a quiz -- and when you assume, you make an ass out of 'u' and 'me.'"

It stuck with me.

Fast-forward to today, and I can't help but be wary of looking for an easement from the Fed for anything short of a financial meltdown. If you read pretty much anything besides the press releases from the National Association of Realtors, you're probably aware there is a lot of concern that assets -- residential housing in particular -- have been massively inflated. Sure, a Fed rate cut would make many people happy, but so would a diet consisting solely of chocolate -- that is, until malnutrition set in.

If economic growth were slowing and inflation were low, that would be one thing. But the fact is that we have slowing growth and upward-trending inflation, suggesting (via Keynes) that we're pushing the limit of our economy's maximum potential output. Cutting rates would likely have little effect on our economic growth, nor would it help us avoid the slowdown that many, including Goldman Sachs (NYSE: GS) analyst Jan Hatzius, see ahead. Instead, it might play more of a role in pushing price levels up further.

I won't bore you here with the reasons why inflation is harmful to the economy, but if you're interested, you can check out this interesting lecture. It's from the American University in Bulgaria and is titled "The 21 Evils of Inflation."

Dropping interest rates may seem like an enticing idea, but it reminds me too much of the Isle of the Sirens in The Odyssey. I just wonder whether there's any way we could tie Big Ben to a ship's mast to prevent him from doing anything rash.

-Kopp 

(Disclosure: I own shares of Goldman stock) 

4 Comments – Post Your Own

#1) On April 02, 2007 at 7:14 PM, Greshm (97.30) wrote:

http://caps.fool.com/Blogs/ViewBlog.aspx?t=01006745959252154676

A star is born!

 

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#2) On April 02, 2007 at 8:26 PM, Greshm (97.30) wrote:

http://caps.fool.com/Blogs/ViewBlog.aspx?t=01006745959252154676

A star is born!

 

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#3) On April 03, 2007 at 10:29 PM, camistocks (< 20) wrote:

Just a the beginning of the youtube clip (21 Evils of inflation) the guy defines inflation:

Inflation is an increase in the money supply and not an increase in prices. Higher prices are the result of inflation.

If the FED was truly concerned with inflation, why are they increasing the money supply at 10%...?

http://www.nowandfutures.com/key_stats.html 

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#4) On April 04, 2007 at 12:19 AM, TMFKopp (98.48) wrote:

Wow didn't realize that'd make me a star! 

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