Wikinvest Wire

Faulting the Caped Crusader

Sunday, January 27, 2008

The current issue of The Economist has a number insightful stories on one aspect or another of last week's financial market turmoil, but after reading Going it alone, on the subject of the growing gap between the Fed and other central banks, the image to the right (only available in the print edition) has stuck with me long past the point when it first became uncomfortable.

Clearly, the purple outfit, the Gotham City searchlight, and the oddly placed scissors are self-explanatory, but is that Ben Bernanke's beard?

Is it just me or are others similarly bothered by what can only be described as, when looked at collectively, a disturbing caricature of our Fed chief?

Elsewhere in the magazine is another "Greenspan mess" sighting in the Economics Focus article, though the separation of the two words almost exceeds the legal limit of two paragraphs or 100 words that qualifies a story for inclusion in this growing list.

In Faulty powers, another anonymous economist wonders if monetary policy still works when used against a slowing economy.

WRITING in Slate magazine in 1997, Paul Krugman, an American economist, neatly captured the widespread belief in the omnipotence of the then-chairman of the Federal Reserve. “If you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: it will be what [Alan] Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God.

Faith in the Federal Reserve is not what it used to be. Since September the Fed has cut its policy rate by 1.75 percentage points, to 3.5%. It still has plenty of firepower left—rates are some way above the 1% level reached in 2003—but few seem willing to rely on monetary policy alone to save the day. Politicians and pundits alike were making a case for a fiscal stimulus package even before the Fed's surprise rate cut on January 22nd. That Ben Bernanke, the Fed chairman today, has given his blessing to the plan only adds to the impression that central banks have lost their grip.

What lies behind this loss of faith? One cause is the feeling that overly loose monetary policy got the economy into this mess. Repeated cuts in interest rates during the last downturn, in 2001-03, fuelled the housing and credit bubbles that are now bursting to such damaging effect. The legacies of that boom—falling asset prices, high consumer debt and bank losses—may now hamper the ability of central banks to prop up spending.

One of the ways that central banks affect the economy is through their influence on the price of assets, like shares or homes. Other things being equal, a reduction in short-term interest rates should bump up asset values, because their stream of future earnings is discounted by a smaller factor. Now that America's housing boom is ending, the worry is that the Fed is less able to stimulate the spending that comes with rising housing wealth. Assets are already dear, it is said; there are no bubbles left to reflate. Falling home prices make for a nation of savers, not shoppers. And firms are not keen to invest when the market value of their assets is shrinking.

Falling asset prices hurt the market for credit too, interfering with another policy channel. Monetary policy affects the choice between spending now or spending later and, for the cash-strapped, credit provides the bridge from the present to the future. Interest rates are the cost of using tomorrow's income to pay for today's spending. Lower rates lift spending by more when there is access to borrowing. Firms and homeowners can borrow cheaply with good collateral, but funds are less abundant when asset values are falling. Consumers may in any case have had their fill of borrowing. Household debt in America has vaulted to more than 130% of disposable income from less than 100% in 2000 (see chart). In Britain the ratio is higher still. And even if credit demand holds up, banks reeling from subprime-related losses are less willing to supply it.
It's called "pushing on a string" and that phrase has yet to be successfully applied to a nation as obsessed as ours with buying stuff they don't need, however, this time may be a real test.

And yes, that's "the distant sound of whirring rotors".

ooo

This week's cartoon:

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2 comments:

EconomicDisconnect said...

I had missed the scissors for glasses motif! Very funny indeed. Humor can have the ability to provide insight from time to time. Can anyone really doubt that the FED rate will be at 1% by August, September the latest? The Wednesday meeting will be a hoot when we see the statement.

Anonymous said...

I am the walrus
Goo goo g' joob

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