November 7, 2002
Why The Federal Reserve Board Lied
“With this action, the Committee believes that, against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are balanced with respect to the prospects for both goals in the foreseeable future.”
FOMC Statement. November 6.
“For the foreseeable future, against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are weighted mainly toward conditions that may generate economic weakness.”
FOMC Statement. September 24.
Suffice it to say, either the Fed is blind or they are up to something. How can the risks between inflation and economic weakness suddenly be ‘balanced’ given that it would take a miraculous economic turn around to simply get back to the poor economic outlook we had in September? What criteria did the Fed use to figure out that a 50 point rate cut immediately takes away the ‘risks’ of slower growth? Has the Fed been looking at the pitiful economic reports the last two weeks?
In fact, what the Fed is doing with their statement is warning investors that they are almost out of ammo, and that yesterday’s rate cut was double the expected dose because a single shot would not be as likely to get the consumer drunk. This is not to say that the Fed knows the rate cut will work. They don’t. If they did they would have cut rates in September!, or when they saw the iceberg nearing.
Even so, the case could be made that the Fed had to add some positive reinforcement to the statement; the case could be made that the Fed had to lie. Why? Because if the Fed had mentioned the phrase ‘economic weakness’ in yesterday’s statement investors would have been left scratching their heads -- ‘the Fed cut by 50 points and still sees the threat of economic weakness?…what else can they do?’
Fed Believes in Being Aggressive
Fed members have always maintained that the Bank of Japan was not accommodative enough to combat deflation in the early 1990s. Quite frankly, and so the logic goes, when using rate reductions to try and stimulate demand it is all about being aggressive. After all, in the Fed’s ‘How to manage the economy’ handbook it states that you can always take back rate cuts at a later date, or after the stimulus has worked its charms.
Yesterday the Fed took its own advice and surprised the market with a larger than expected rate cut. This ensures that the Fed is not behind the curve.
The big gamble, of course, is that the U.S. economy will not respond; that business demand remains soft and consumer demand continues to soften. If this happens at least the Fed can plead innocence – just like they did with the stock market bubble – because yesterday’s lie is proof that the Fed believes they have done all they can do.
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