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Politics : Ask Michael Burke -- Ignore unavailable to you. Want to Upgrade?

To: Skeeter Bug who wrote (67288)	9/6/1999 10:47:00 AM
From: Les H	Read Replies (1) \| Respond to of 132070

Fed fuels inflation by bias towards Wall St by ANDREW SMITHERS Chairman of fund manager advisers Smithers & Co thisislondon.co.uk Over the past year, US inflation is up and nominal interest rates are down. This is dangerous. Interest rates have to rise faster than prices to slow an economy. As inflation rises, the tougher policy has to become. This makes a recession more likely. The rise in inflation is a sign that the US economy is overheating. There are plenty of other warning signals. Money supply has been growing at 10% a year, unemployment is at record lows and Wall Street at a record high. The Federal Reserve's policy looks reckless, but if inflation does not get worse it will have shown good judgment, or at least good luck. On the evidence it is taking a big risk and, at first sight, a rather unnecessary one. As small interest rate rises have only a mild and much-delayed impact on an economy, it seems odd that the Fed has not been a bit tougher. The problem, of course, is the stock market. History shows that asset bubbles are disastrous for economies. The US has experienced five this century, in 1906, 1929, 1937, 1968 and now. In each previous case they were followed by major recessions. Avoiding asset bubbles, therefore, is a central banker's most important job. Last year the Fed cut rates. Its concern was the condition of financial markets rather than the condition of the economy. This sign that Wall Street has become the Fed's greatest worry has just been confirmed. Fed chairman Alan Greenspan has remarked that central bankers should take asset prices into account in formulating monetary policy. This worried the stock market, but probably for the wrong reasons. The market thought that it meant that the Fed would tighten interest rates more readily because of the Wall Street bubble. This is most unlikely. It is already far too late to stop the bubble. The Fed worries that it will have to raise interest rates to stop inflation. When it does, it wants the stock market to fall slowly, rather than crash. Greenspan's comments were intended to reassure investors, not frighten them. Greenspan said he would not put up interest rates just because the stock market is too high. Only sharp falls or rises in share prices would be the signal for action. In practice this means the Fed will be prepared to cut interest rates when the stock market falls, but never put them up when it rises. This is because stock markets do not behave symmetrically. They fall faster than they rise. So the Fed's policy must be equally asymmetric. It will favour interest rate cuts over rises which means, of course, that it will be biased towards inflation. Greenspan has merely spelled out in words what his actions have already shown. If the Fed was not biased towards inflation interest rates would be higher, not lower, than they were last year. He was not threatening to put up interest rates, he was simply confirming that falls in the Dow Jones rather than rises in the rate of inflation, have become the target for monetary policy.