The Fed’s decision to send interest rates lower by one-quarter percentage point was no surprise Tuesday, although it likely capped an extraordinary year for the central bank.
Next year may bring an improving economy, but policymaking by the Federal Reserve Bank is likely to be contentious. Why? Because any signs of recovery would mean that the Fed should start increasing interest rates again.
Some background: Three unscheduled meetings and 11 consecutive decisions to expand the money supply in 12 months are unprecedented in Fed history. Dropping the Fed funds rate by 4.75 percentage points—from 6.5 percent to 1.75 percent—in one uninterrupted cascade has never been done before.
In their official statement Tuesday, the central bankers noted the obvious. The U.S. economy is weak, and there’s virtually no danger of inflation in the immediate future. No one dissented from the decision in favor of further monetary easing. But that harmony will end.
Since monetary policy operates with long lags–the rate cuts made last January typically would be kicking in about now–the Fed needs to shift policy well before the economy clearly shows vigor.
Choosing the right moment, however, is always difficult.
Economists are lousy at predicting when an economy will change from growth to recession–the question faced a year ago–or from recession back to growth.
Given long lags, central bankers frequently have to act well before changes in economic trends are clearly discernable.
After a full year of successive easing, any tightening will be controversial. The public and the general media frequently don’t get the nuances of economic policy-making, and any eventual interest rate increases are sure to be met with storm of criticism.
Democratic members of Congress will call any Fed tightening as inopportune and misguided. They’ll be joined by many Republican colleagues and members of the administration who are concerned about the off-year election.
Monetary policy changes in any election year always raise controversy.
Midterm elections are a particular nightmare for any first-term president whenever the economy is in the doldrums. And after Vermont Senator Jim Jeffords left the GOP, Congress has been balanced on a knife’s edge. All 435 House seats are up for grabs, and some Democrats hope that they can regain a majority there for the first time in eight years.
A key question then is how we’ll be able to tell when the Fed is about to shift.
Without resorting to any “great man” theory of history, it’s clear that in monetary policy, personalities sometimes play a role. And the personalities on the Federal Open Market Committee change each year, according to the law.
Boston’s Cathy Minehan, Kansas City’s Tom Hoenig , Chicago’s Michael Moskow and William Poole from St. Louis cast their last votes Tuesday. The seats they held for a year will be filled by Anthony Santomero from Philadelphia, Gary Stern from Minneapolis, Jerry Jordan from Cleveland and Bob McTeer from Dallas.
Will this reshuffling affect the average U.S. household?
Probably not in any major way. But look to Minneapolis’s Stern or Cleveland’s Jordan as proponents of tightening money supply.
Both are old timers on the committee. Stern dates to the Paul Volcker era and Jordan from 1992. Both have reputations as inflation “hawks” who are wary of too-easy money and who aren’t afraid to cast a dissenting vote.
If they openly disagree with a decision to ease further or to refrain from tightening, it’ll be a sign that the mood is shifting. Moreover, if issues are such that either of these members wants their dissent recorded, they probably have some silent sympathizers among the rest of the body
McTeer is less likely to make waves and Santomero, appointed only last year, has no voting record for Fed watchers to go on.
© 2001 Edward Lotterman
Chanarambie Consulting, Inc.