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Monday, October 09, 2006

Poole: The Economy Can Take Care of Itself

Bill Poole, president of the St Louis Fed, says the economy is self-correcting -- there's not much need for the Fed to get involved. He says, "The FOMC can some of the time – maybe even much of the time – sit back and do relatively little":

St Louis Fed chief says bonds can bring stability, by Krishna Guha, Financial Times: The Federal Reserve could “sit back” and let the bond market play the role of automatic stabiliser in the economy, even amid concern over the housing slowdown, Bill Poole, president of the St Louis Fed, has told the Financial Times.

Mr Poole, ... said that the fall in long-term interest rates within the bond market had reduced pressure on the Fed to respond immediately to signs of economic weakness. “The decline in long rates is working as a built-in stabiliser for the economy,” he said, noting that the fall in bond market rates “will tend to bring down mortgage rates” as well.

By the same token, Mr Poole said, “if we get an upside surprise, the long rate clearly has a lot of room to rise without the FOMC doing anything.” ... “The FOMC can some of the time – maybe even much of the time – sit back and do relatively little, relying on the stabilising effect of market reactions to current data,” he said. “We don’t have to do it all.”

Mr Poole said the Fed would “eventually have to follow through” to validate market expectations, but not immediately. His comments lend weight to the view that the Fed could remain on pause for some time, rather than reacting swiftly to the housing-led slowdown.

Mr Poole said the stimulative effect of lower long-term rates in the bond market would work through several interest-rate sensitive sectors in the economy. “Housing is clearly quite interest sensitive,” he said. “But auto sales are also interest sensitive. Corporate investment is interest sensitive to a degree.”

Mr Poole ... said that risks to growth were more prominent today, relative to risks to inflation, than they were a few months ago. “It seems to me that the pressure on inflation has come off a bit,” he said, noting that house price data might not capture the full extent of declines in house prices. ... Mr Poole said he regarded the policy outlook as “roughly symmetrical”. ...

There are questions about the Fed's ability to control long-rates in the global economy, so the Fed may not have much choice except to "sit back and do relatively little." Even so, my position is more activist, though not to the level of trying to fine-tune every expected movement in output and inflation.

Thinking about fine-tuning reminds me of my sideburns. If I try to fine-tune them and get them even by going from side-to-side, taking a little more off each time to get them perfectly even, I generally end up with no sideburns at all. I've ruined more than one project trying to get things perfect. There's a point where well- enough should be left alone.

For monetary policy, the activist versus passive policy decision rests upon the Fed's ability to control long-term rates, the degree to which long-term rates affect investment and consumption, the lags between policy changes and the effects on the economy as compared to how fast the economy self-corrects, our ability to forecast the economy's future, and our ability to determine the current state of the economy, e.g. variables such as the current natural rate of output and unemployent versus actual conditions, or the inflation rate. There are also different views about which model to use to make these determinations (e.g. Real Business Cycle models versus New Keynesian models), some strongly held, as well as differences among proponents of each model how they should be specified. The large degree of uncertainty concerning some of these effects and linkages, and the difference in views as to the correct theoretical specification to use explain much of the difference in views about how monetary policy should be conducted.

    Posted by on Monday, October 9, 2006 at 03:33 PM in Economics, Housing, Monetary Policy | Permalink  TrackBack (0)  Comments (22)


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