I can’t see how credibility on inflation is much of an issue. Misjudgement on inflation yes. A 1% rate cut might well misjudge the issue in which case, as Feldstein says, we pay slowly into the future as we bring inflation back into line. In his judgement that’s a risk worth taking. I think I agree.

I’ve always thought that our thinking on monetary policy is a bit influenced by wish fulfilment. I remember saying to people making the decisions when we were reducing rates after the horror stretch of 1990 “if you think the rates have done their job why the hell don’t you take them down quickly. From memory cash rates were at 17% and they were reduced one percentage point at a time. Even if you didn’t know that inflation had been licked and that we were heading for nominal rates between 6-8% in the future, it seemed to me then that you should have cut rates from 17% by 2- 2.5% to start with at least – and then another 1 or two percent as you became more sure that you’d slowed the economy.

But the kind of thinking that was taking place was this. “The economy is a big big ship. It takes a long time to turn round, so we should change rates slowly.”

Well if you were on the Titanic and you saw an iceberg, would you swing the rudder slowly or quickly?

I like the decisiveness of Feldstein’s piece. I see no problem with a 1% cut and if you turn out to be wrong, up they go again – and we get some costs into the future. But I doubt they’re as high as the costs of the recession we’re trying not to have.

Policy makers are facing a nightmare balance of risks – a serious economic downturn versus an increase in inflationary pressures. When in such a situation, central banks need to find a middle of the road compromise. This suggests a decrease of 0.5 percentage points in the Federal funds rate. If it went as far as a 1 percentage point reduction, the Bank could lose all its hard-won credibility on inflation. I am not a hard liner on inflation at all but it has been a long bloody battle to get inflationary expectations down. We cannot capitulate now.

Christopher Palmeri of
Businessweek has written of the “life” of a very small
house in Los Angeles’ Hancock Park neighbourhood. The
house, built in 1921 is but 1300 square feet, and is recent
history is as follows:
July, 1994: A couple purchases the house for
$23,000, borrowing $218,000 at 6.75% from Jon
Douglas Finance.
March, 2003; The refinance, borrowing $313,000
from the Downey Savings & Loan at an
adjustable rate starting at 3.5%.
July, 2005: They sell to a flipper for $815,000.
He borrows $570,000 from Loan Center of
California at 6.75% and an additional $244,000
from the same lender. He spends $115,000 on
remodelling.
March, 2006: The house is sold for $1.29
million. The buyer borrows just over $1 million
from First Franklin, now a unit of Merrill Lynch at
7.5% and an additional $259,000 from the same
source.
August, 2007: On behalf of mortgage investors,
the house is foreclosed on. It is listed by Re/Max
at $900,000. Broker Kenneth Davis says an offer
has been accepted at “close to asking.

look the fact is that the US needs to clean up the books after years of mal-investments, so if were up to me i’d leave interest rates alone for a while and see where the cards fall.

The other really good trhing they could do is lower the discount rate at the window and see what happens.

the best thing may be to allow the recession to run its course and do nothing.

The US has been running an uninterupted trade deficit since 1975. Thats’s over 30 years! The US has run a trade deficit for a good part of it’s life.

If Helicopter Ben had bothered the read last month’s TIC data he would have seen that it wasn’t private investors that financed the short fall, it was governments from around the world. You don’t want this to be a trend!

The worst thing you can do is highlight your weaknesses to the private market who are really just a bunch of chicken littles. Uncle Al would never have done that!

The problem with Helicopter Ben is that he has no market experience compared to Al.

Trade deficits don’t really matter all that much as long as you are able to finance them and so they’re only a problem when they beocome a problem and not one moment sooner.

There is all sorts of damage a Fed governor can cause by saying this, the wrost of which is higher bond rates at a time when the credit spread is widening and risk appetite jaws and closing.

Someone should tell Heli Ben that you don’t try to run when your pants are down to your ankles!

Cutting rates is what is needed, but the psychology of the market is very fragile, and cutting them by one per cent in one go would smack of panic by the Fed, and lead people to think that they know something really, really bad is about to happen. Then we’d get panic selling of everything, liquidity would dry up even more and we’d have a real crisis.

Slow and steady is the way to fix the problem and manage te market psychology.

JC: You’re such an optimist — I really don’t think it matters if he highlights the trade deficit or not. I’m sure the people owed the trillions of dollars are quite aware of it and want a decent return. I also doubt that the people owed the money really care if the US goes into stagflation because of it.

There has been fed speak galore in the past 48 hours with various Fed governors offering their “valued” opinions about all sorts of things.

Bernanke made what i thought was a staggering silly comment for a fed governor proving once again that Uncle Al is a person who will be missed.

This is what he said:

the large US current account deficit cannot persist indefinitely because the ability of the United States to make debt service payments and the willingness of foreigners to hold US assets in their portfolios is limited.

Two problems with this.

1. Does he want to create a stampede out of the dollar once he starts lowering rates?

2. Why is he higlighting the trade deficit if he needs foreigners to finance it while telling them not to be the last elephant out of the key hole.

As for the other chattering Fed board members, it seems there isn’t the urgency in their voices or that they understand the gravity of the problem.

They will cut on the 18th, but the dollar seems gone for all money.