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To: Greg h2o who wrote (11011)	10/22/2003 11:51:59 AM
From: bob zagorin	Read Replies (1) \| Respond to of 13797

i wonder if this helped spook the markets today.. Two Fed Officials Dare to State the Obvious: Caroline Baum Oct. 21 (Bloomberg) -- Two Federal Reserve policy makers broke ranks last week. St. Louis Fed President Bill Poole and San Francisco Fed President Bob Parry offered some much-needed refinement to the Fed's standard boilerplate that policy can remain accommodative for a considerable period. Their refinements were both conceptual and definitional. On the conceptual side, Poole addressed the relationship between productivity and real rates in light of the possibility that underlying productivity growth has increased again -- from 1.5 percent in the mid-1970s to mid-1990s, to 2.5 percent in the late 1990s, to something even higher today. If that's the case, ``and if the FOMC does not make appropriate policy adjustments, inflation could drift away from current low levels,'' Poole said in a speech last Tuesday. Both econometric models and intuition support the notion that the real rate of interest should equal the economy's potential growth rate, which is determined by population and productivity growth, Poole said. ``If monetary policy adjustments do not keep up with a rising equilibrium real rate of interest, then the inflation rate may ultimately rise,'' Poole said. Poole agreed with many of his colleagues, including Fed governor Ben Bernanke, that in the short run higher productivity growth could depress the inflation rate. ``However, over the longer run higher productivity growth will probably require higher interest rates,'' Poole said. Thrust and Parry While Poole's analysis of the convergence between real rates and economic growth was directed at long-term rates, real short rates, currently near zero, ultimately respond to the same longer- term fundamentals, specifically productivity growth, he said. Call this Shot No. 1 across the bow. Rates will have to rise, not fall, because of higher productivity growth. A failure to recognize and respond to the change in trend productivity growth would be to ignore the lesson of the 1970s, when an unidentified fall in productivity growth led to an overestimation of the economy's non-inflationary growth rate and an extended period of high inflation. While Poole was providing a conceptual framework for higher real rates -- he didn't attach any time frame to his argument that the equilibrium real rate could be 4 percent -- Parry was augmenting the definition of accommodative. Accommodative Range In a response to a question following a speech last Thursday, Parry said ``accommodative policy is not necessarily a time when interest rates are just kept flat, but below the real equilibrium rate if the economy is growing at potential. We're so far away from that point it's clear we can remain accommodative for a long time.'' Call this Shot No. 2. The equilibrium rate, which is unknowable, would keep a fully employed economy growing at its non-inflationary potential forever. The equilibrium long-term rate -- the rate at which capital is allocated from desired lenders to desirable borrowers -- is set by the market. The Fed disturbs the equilibrium, so to speak, by pegging a short-term rate, whose interaction with the long rate determines how accommodative policy is. Given Poole's conceptual formula that the equilibrium real rate could be 4 percent -- 3 percent productivity growth + 1 percent population growth -- and Parry's definitional framework that accommodative is less than equilibrium, we conclude that there's a gaping hole between current short and long rates and their equilibrium. The real 10-year yield, gleaned from the Treasury's 10-year inflation indexed bond, is 2.1 percent, well below Poole's hypothetical equilibrium. At 1 percent, the overnight federal funds rate is well below its equilibrium, too. Long Day's Journey The search for an equilibrium real rate lacks urgency when the economy isn't fully employed. Yet it helps to have an idea of the extent of the journey from point A to an estimated point B and someone willing to admit it. Neither Parry nor Poole said anything earth-shattering last week; just a statement of the obvious. The fact that together they gave voice to the idea that rates a) have to move higher in the future and b) can move higher and still be accommodative was a change of pace for the one-note Fed. The Fed's reassurance of policy accommodation for a considerable period was intended to quell the bond market sell- off. Reiteration without explanation had the added effect of putting the Fed in contention for perpetrator of the most overused mantra -- right up there with the Treasury and its strong-dollar policy. Lone Voices The refreshing comments by Parry and Poole, in conjunction with a raft of strong economic data, ignited expectations of a rate increase in the first half of next year. The fed funds futures market fully incorporated a 25 basis-point increase at the May 4 meeting. The fact that the comments came from the hinterlands -- the District Banks -- and not the Board in Washington ensures that Poole and Parry were independent voices, not part of a master plan by Fed chairman Alan Greenspan to extricate the Fed from a box of its own design. Maybe the violent move in interest rates over the last five months resonated with Messrs. Poole and Parry. They probably realize that when it comes to movements in interest rates, the Fed's considerable rhetorical efforts at accommodating the markets can't hold a candle to the dynamics of the economy itself. Caroline Baum is a columnist for Bloomberg News. The opinions expressed are her own. Last Updated: October 21, 2003 00:00 EDT