Fed Leaves Interest Rates Unchanged

Here's the press release:

Press Release

Release Date: September 16, 2008

For immediate release

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Ms. Cumming voted as the alternate for Timothy F. Geithner

I don't have any problems with this outcome. Lowering the target interest rate would increase inflation risk, but it wouldn't do much to stimulate the economy or to resolve the financial crisis, those solutions lie with fiscal policy (jump starting the economy) and with lender of last resort, regulatory, etc., type functions of the Fed and Treasury (the crisis). Brad DeLong, however, says "A Mistake, I Think".

Comments

[John V]

How is malinvestment supposed to be wrung out of the economy so we can recover a bit if the economy keeps getting artificial stimulus through very low interest rates? Eventually, all this hyper-liquidity will fail, inflation will sky rocket, interest rates will shoot up and this will all be for naught.

Teasing market forces in the short run is not the same as controlling longer run outcomes. Economists can do the former so well that they ignore that they cannot do the latter. And what they do in short run will affect the pain of the long run results in a negative way. They cannot make things "BE" anything other than what they are. They can only make they "SEEM" so. And that masquerade will come with a price.

The more I see basic forces bludgeon complex wizardry back to reality, the less I think of the people and the institutions they create to defy basics.

[S Brennan]

Mark,

What about exports which are the only bright spot in the economy...won't exports suffer with a higher interest rate?

[John V]

And I know, I'm that dogmatic "market fundamentalist" who doesn't understand how complex this is and how inadequate my POV is. But as each day goes by and they very predictable (from my dogmatic view) results come to fruition, the more I wear that badge with honor. "Fundamentals" in finance and monetary policy as well as real estate markets and housing prices are not malleable variables. They don't change. They are what they are. If that belief in fundamentals is wrong, they I'm correct by sheer luck and it doesn't matter. But if that belief is correct and well-founded, then it really makes you wonder what the heck our perverse policies in the matters are really respecting and being mindful of.

What a mess.

[donna]

Save the last bullet for when we need it. No point shooting the dead horse right now.

[Robinia]

Save the last bullet for when we need it. No point shooting the dead horse right now.

Precisely, donna.

[Winslow R.]

John V. wrote ""Fundamentals" in finance and monetary policy as well as real estate markets and housing prices are not malleable variables. They don't change. They are what they are."

Not to be snarky, but what are they?

[BJ Feng]

I'm surprised that the FOMC actually has a backbone. It's time they figured out the game. The people who benefit from rate cuts always scream for a cut, and find all sorts of reasons as to why a cut is needed to prevent economic collapse, regardless of the real economic situation.

A rate cut would have very little effect, the problem isn't high interest rates. Real interest rates are negative right now, to the tune of almost -3%! The problem is with solvency, no amount of cuts can make a bad loan into a good loan, or reduce the risk that some of these companies have taken.

The stock market is up big now, after selling off sharply when the news broke. There was booing and curses shouted in the equity pits, you could hear the boos on CNBC, but like a kid throwing a tantrum, it's quickly forgotten.

[Barkley Rosserr]

S Brennan,

This is not "a higher interest rate;" it is "not a lower interest rate," or to be more precise, "not a lower target federal funds rate," as actual interest rates may be going up due to the rising risk spreads. But the same thing is happening in other countries as well. So, not clear there is any push one way or the other on the value of the dollar, especially given that forex rates are probably the least predictable of all macro variables, and even more so in periods of fundamantal volatility like we are in now.

[pgl]

I guess I see the risk of recession to be the much larger concern - so I was hoping for a rate reduction.

[Trust]

Its not possible to create enough new money to replace the loans foreign savers used to make. More printing now would only drive foreign savers away due to inflation/exchange rate risk. The only way to resolve the credit crisis is to restore trust. Rates are far too low to entice domestic savers to put significant money in banks, so restoring the trust of foreign savers are the only game in town.

[Bruce Wilder]

Trust, I think it would be wiser, on the whole, to continue to push the dollar down in forex markets.

Aiding the Chinese and American corporate plutocracy in making China a better investment than Michigan, in order to make Manhatten rich, has just not worked out.

[Trust]

Then who would loan people toasters to buy homes with?

[S Brennan]

C'mon Barkley,

What's with the sophomoric rhetorical games?

"This is not "a higher interest rate;" it is "not a lower interest rate," or to be more precise, not a lower target federal funds rate" - Barkley Rosserr

Why not "...the earth is not 4 billion years OLD, it's not 4 billion years young either, it's just right".

For crying out loud Barkley, the meaning was clear. When people try to act superior with this kinda stuff you have to wonder what else is in the sewer?

And since you went out of your way to stick a burr under my saddle, it's pretty clear that the economic profession as a whole has led the US population off a cliff by defending a good chunk of Friedman's intellectual junk, while deriding those who perhaps lacked an economics degree, but who could see the handwriting on the wall for the past three decades.

To be clear, China didn't rise by accident, it's command economy was dedicated to creating a manufacturing base that was fully integrated. They're not quite their yet, but it's coming and to my eyes it doesn't look too different from a more powerful version of Mussolini's Italy.

Meanwhile in Manhattan, the boys with the bucks have made a killing selling their fellow Americans out for pennies on their hard earned tax dollars. Oh...but those pennies ad up when they go to so few. All the while, the Milton Friedman's of the world sold snakeoil, shouting "buyer beware"...or was it "Free To Choose"? And very few economists stood on their hind legs to challenge the darkness of unbridled greed. After all, bucking the dark lord would not help you get tenure...would it Barkley?

[John V]

it's pretty clear that the economic profession as a whole has led the US population off a cliff by defending a good chunk of Friedman's intellectual junk

What part of Friedman's "junk" had role in this?

[John V]

Winslow R,

A simple way to put the idea of fundamentals in this sense is that the real price of anything (money, homes, real estate, risk...anything) is always present in any market...no matter how distorted...and will always assert itself in the end regardless of any tricks that make them appear to be otherwise.

[S Brennan]

John V,

Let me know if you want more:

"For decades, Milton Friedman's public image and fame were defined largely by his pronouncements on monetary policy and his creation of the doctrine known as monetarism. It's somewhat surprising to realize, then, that monetarism is now widely regarded as a failure, and that some of the things Friedman said about "money" and monetary policy—unlike what he said about consumption and inflation—appear to have been misleading, and perhaps deliberately so.

...If the Fed decides to increase the money supply, all it does is purchase some government bonds from private banks, paying for the bonds by crediting the banks' reserve accounts—in effect, all the Fed has to do is print some more monetary base. By contrast, fiscal policy involves the government much more deeply in the economy, often in a value-laden way: if politicians decide to use public works to promote employment, they need to decide what to build and where. Economists with a free-market bent, then, tend to want to believe that monetary policy is all that's needed; those with a desire to see a more active government tend to believe that fiscal policy is essential.

Economic thinking after the triumph of the Keynesian revolution—as reflected, say, in the early editions of Paul Samuelson's classic textbook[*]—gave priority to fiscal policy, while monetary policy was relegated to the sidelines. As Friedman said in his 1967 address to the American Economic Association:

The wide acceptance of [Keynesian] views in the economics profession meant that for some two decades monetary policy was believed by all but a few reactionary souls to have been rendered obsolete by new economic knowledge. Money did not matter.
Although this may have been an exaggeration, monetary policy was held in relatively low regard through the 1940s and 1950s. Friedman, however, crusaded for the proposition that money did too matter, culminating in the 1963 publication of A Monetary History of the United States, 1867–1960, with Anna Schwartz.

Although A Monetary History is a vast work of extraordinary scholarship, covering a century of monetary developments, its most influential and controversial discussion concerned the Great Depression. Friedman and Schwartz claimed to have refuted Keynes's pessimism about the effectiveness of monetary policy in depression conditions. "The contraction" of the economy, they declared, "is in fact a tragic testimonial to the importance of monetary forces."

But what did they mean by that? From the beginning, the Friedman-Schwartz position seemed a bit slippery. And over time Friedman's presentation of the story grew cruder, not subtler, and eventually began to seem—there's no other way to say this—intellectually dishonest."

In interpreting the origins of the Depression, the distinction between the monetary base (currency plus bank reserves), which the Fed controls directly, and the money supply (currency plus bank deposits) is crucial. The monetary base went up during the early years of the Great Depression, rising from an average of $6.05 billion in 1929 to an average of $7.02 billion in 1933. But the money supply fell sharply, from $26.6 billion to $19.9 billion. This divergence mainly reflected the fallout from the wave of bank failures in 1930–1931: as the public lost faith in banks, people began holding their wealth in cash rather than bank deposits, and those banks that survived began keeping large quantities of cash on hand rather than lending it out, to avert the danger of a bank run. The result was much less lending, and hence much less spending, than there would have been if the public had continued to deposit cash into banks, and banks had continued to lend deposits out to businesses. And since a collapse of spending was the proximate cause of the Depression, the sudden desire of both individuals and banks to hold more cash undoubtedly made the slump worse.

Friedman and Schwartz claimed that the fall in the money supply turned what might have been an ordinary recession into a catastrophic depression, itself an arguable point. But even if we grant that point for the sake of argument, one has to ask whether the Federal Reserve, which after all did increase the monetary base, can be said to have caused the fall in the overall money supply. At least initially, Friedman and Schwartz didn't say that. What they said instead was that the Fed could have prevented the fall in the money supply, in particular by riding to the rescue of the failing banks during the crisis of 1930–1931. If the Fed had rushed to lend money to banks in trouble, the wave of bank failures might have been prevented, which in turn might have avoided both the public's decision to hold cash rather than bank deposits, and the preference of the surviving banks for stashing deposits in their vaults rather than lending the funds out. And this, in turn, might have staved off the worst of the Depression.

An analogy may be helpful here. Suppose that a flu epidemic breaks out, and later analysis suggests that appropriate action by the Centers for Disease Control could have contained the epidemic. It would be fair to blame government officials for failing to take appropriate action. But it would be quite a stretch to say that the government caused the epidemic, or to use the CDC's failure as a demonstration of the superiority of free markets over big government.

Yet many economists, and even more lay readers, have taken Friedman and Schwartz's account to mean that the Federal Reserve actually caused the Great Depression—that the Depression is in some sense a demonstration of the evils of an excessively interventionist government. And in later years, as I've said, Friedman's assertions grew cruder, as if to feed this misperception. In his 1967 presidential address he declared that "the US monetary authorities followed highly deflationary policies," and that the money supply fell "because the Federal Reserve System forced or permitted a sharp reduction in the monetary base, because it failed to exercise the responsibilities assigned to it"—an odd assertion given that the monetary base, as we've seen, actually rose as the money supply was falling. (Friedman may have been referring to a couple of episodes along the way in which the monetary base fell modestly for brief periods, but even so his statement was highly misleading at best.)

By 1976 Friedman was telling readers of Newsweek that "the elementary truth is that the Great Depression was produced by government mismanagement," a statement that his readers surely took to mean that the Depression wouldn't have happened if only the government had kept out of the way—when in fact what Friedman and Schwartz claimed was that the government should have been more active, not less.

Why did historical disputes about the role of monetary policy in the 1930s matter so much in the 1960s? Partly because they fed into Friedman's broader anti-government agenda, of which more below. But the more direct application was to Friedman's advocacy of monetarism. According to this doctrine, the Federal Reserve should keep the money supply growing at a steady, low rate, say 3 percent a year—and not deviate from this target, no matter what is happening in the economy. The idea was to put monetary policy on autopilot, removing any discretion on the part of government officials.

Friedman's case for monetarism was part economic, part political. Steady growth in the money supply, he argued, would lead to a reasonably stable economy. He never claimed that following his rule would eliminate all recessions, but he did argue that the wiggles in the economy's growth path would be small enough to be tolerable—hence the assertion that the Great Depression wouldn't have happened if the Fed had been following a monetarist rule. And along with this qualified faith in the stability of the economy under a monetary rule went Friedman's unqualified contempt for the ability of Federal Reserve officials to do better if given discretion. Exhibit A for the Fed's unreliability was the onset of the Great Depression, but Friedman could point to many other examples of policy gone wrong. "A monetary rule," he wrote in 1972, "would insulate monetary policy both from arbitrary power of a small group of men not subject to control by the electorate and from the short-run pressures of partisan politics."

Monetarism was a powerful force in economic debate for about three decades after Friedman first propounded the doctrine in his 1959 book A Program for Monetary Stability. Today, however, it is a shadow of its former self, for two main reasons.

First, when the United States and the United Kingdom tried to put monetarism into practice at the end of the 1970s, both experienced dismal results: in each country steady growth in the money supply failed to prevent severe recessions. The Federal Reserve officially adopted Friedman-type monetary targets in 1979, but effectively abandoned them in 1982 when the unemployment rate went into double digits. This abandonment was made official in 1984, and ever since then the Fed has engaged in precisely the sort of discretionary fine-tuning that Friedman decried. For example, the Fed responded to the 2001 recession by slashing interest rates and allowing the money supply to grow at rates that sometimes exceeded 10 percent per year. Once the Fed was satisfied that the recovery was solid, it reversed course, raising interest rates and allowing growth in the money supply to drop to zero.

Second, since the early 1980s the Federal Reserve and its counterparts in other countries have done a reasonably good job, undermining Friedman's portrayal of central bankers as irredeemable bunglers. Inflation has stayed low, recessions—except in Japan, of which more in a second—have been relatively brief and shallow. And all this happened in spite of fluctuations in the money supply that horrified monetarists, and led them—Friedman included—to predict disasters that failed to materialize. As David Warsh of The Boston Globe pointed out in 1992, "Friedman blunted his lance forecasting inflation in the 1980s, when he was deeply, frequently wrong."

- Krugman

[John V]

S Brennan,

weak effort on your part.

The Federal Reserve officially adopted Friedman-type monetary targets in 1979, but effectively abandoned them in 1982 when the unemployment rate went into double digits. This abandonment was made official in 1984, and ever since then the Fed has engaged in precisely the sort of discretionary fine-tuning that Friedman decried.

Even Krugman won't lie about this....

I'll still wait.

[S Brennan]

most influential people have been so converted to the Friedman way of thinking that it is simply taken as a given that the change in economic policies he promoted has been a force for good. But has it?

Consider first the macroeconomic performance of the US economy. We have data on the real income—that is, income adjusted for inflation—of American families from 1947 to 2005. During the first half of that fifty-eight-year stretch, from 1947 to 1976, Milton Friedman was a voice crying in the wilderness, his ideas ignored by policymakers. But the economy, for all the inefficiencies he decried, delivered dramatic improvements in the standard of living of most Americans: median real income more than doubled. By contrast, the period since 1976 has been one of increasing acceptance of Friedman's ideas; although there remained plenty of government intervention for him to complain about, there was no question that free-market policies became much more widespread. Yet gains in living standards have been far less robust than they were during the previous period: median real income was only about 23 percent higher in 2005 than in 1976. -Krugman

[John V]

S Brennan,

You're veering off topic.

You said Friedman's junk caused this mess. I'm still waiting.

You gave something long and specific which turned to have nothing. Now you're just throwing anecdotes and generalizations.

I'm still waiting.

[S Brennan]

"[A]nother important reason for the lag in most families' living standards was a spectacular increase in economic inequality: during the first postwar generation income growth was broadly spread across the population, but since the late 1970s median income, the income of the typical family, has risen only about a third as fast as average income, which includes the soaring incomes of a small minority at the top.

This raises an interesting point. Milton Friedman often assured audiences that no special institutions, like minimum wages and unions, were needed to ensure that workers would share in the benefits of economic growth. In 1976 he told Newsweek readers that tales of the evil done by the robber barons were pure myth:

"There is probably no other period in history, in this or any other country, in which the ordinary man had as large an increase in his standard of living as in the period between the Civil War and the First World War, when unrestrained individualism was most rugged."[1] - Friedman

(What about the remarkable thirty-year stretch after World War II, which encompassed much of Friedman's own career?) Yet in the decades that followed that pronouncement, as the minimum wage was allowed to fall behind inflation and unions largely disappeared as an important factor in the private sector, working Americans saw their fortunes lag behind growth in the economy as a whole." - Krugman

[1] This ignores the role that technology plays in human's development, however, to be fair to Friedman, most economists are similarly myopic.

[John V]

S Brennan,

This is all simply predictable editorializing and argument for a POV. I'm still waiting for Friedman's "junk" that caused this mess.

[S Brennan]

"...[O]ne of Friedman's key targets was what he considered the uselessness and counterproductive nature of most government regulation. In an obituary for his one-time collaborator George Stigler, Friedman singled out for praise Stigler's critique of electricity regulation, and his argument that regulators usually end up serving the interests of the regulated rather than those of the public. So how has deregulation worked out?

The California electricity crisis of 2000– 2001—in which power companies and energy traders created an artificial shortage to drive up prices—reminded us of the reality that lay behind tales of the robber barons and their depredations. While other states didn't suffer as severely as California, across the nation electricity deregulation led to higher, not lower prices." - Krugman

[John V]

S Brennan,

I'm still waiting.

[S Brennan]

"Those states that, for whatever reason, didn't get on the deregulation bandwagon in the 1990s now consider themselves lucky. And the luckiest of all are those cities that somehow didn't get the memo about the evils of government and the virtues of the private sector, and still have publicly owned power companies. All of this showed that the original rationale for electricity regulation—the observation that without regulation, power companies would have too much monopoly power—remains as valid as ever.

Should we conclude from this that deregulation is always a bad idea? No—it depends on the specifics. To conclude that deregulation is always and everywhere a bad idea would be to engage in the same kind of absolutist thinking that was, arguably, Milton Friedman's greatest flaw." - Krugman

[John V]

S Brennan,

Any day now....

[S Brennan]

"Friedman's laissez-faire absolutism contributed to an intellectual climate in which faith in markets and disdain for government often trumps the evidence. Developing countries rushed to open up their capital markets, despite warnings that this might expose them to financial crises; then, when the crises duly arrived, many observers blamed the countries' governments, not the instability of international capital flows. Electricity deregulation proceeded despite clear warnings that monopoly power might be a problem; in fact, even as the California electricity crisis was happening, most commentators dismissed concerns about price-rigging as wild conspiracy theories. Conservatives continue to insist that the free market is the answer to the health care crisis, in the teeth of overwhelming evidence to the contrary." - Krugman

[John V]

S Brennan,

Are you actually going to point anything in Friedman's junk that has to do with the financial meltdown or are you just going to keep hiding behind's Krugman's punditry and anecdotes on unrelated while pretending it matters here?

[JV Team]

JV:

That you have a problem with Krugman - and you do - doesn't make him wrong. There's no pretending about it, you should learn some history.

You are the one hiding behind ideology, that and your overzealous love for Friedman (which blinds you - Friedman was much worse at being an ideologue than Krugman - go read the record honestly).

Did you know that the JB Clark award that Krugman won is much harder to win that the Nobel Friedman won (since it is only every other year, and it is limited by age)? Don't dismiss what Krugman says just because it tars your heroes with the truth.

[John V]

Overxealous love for Friedman?

Strawman.

This has nothing to do with Krugman.

You made a comment and asked you to substantiate it and you simply haven't.

You keep trying make this about anything other than Friedman's junk which caused the financial meltdown.

I'm still waiting. If you don't have anything, then let it go.