Friday, February 09, 2007

Highlights from Poole

St. Louis Federal Reserve President William Poole gave a speech in St. Louis today on the state of the economy. I am looking at this as a preview of Bernanke's congressional testimony on 2/14. Here are some highlights.

He is upbeat on the economy, and believes the housing market is at or near a bottom:

"My own take on what “moderate pace” means is that real GDP is likely to increase by roughly 3 percent over the four quarters of this year—particularly if the housing market is near an inflection point and no longer a significant drag on growth."

His next statement is key, as it emphasizes the view that monetary policy is just right where it is.

"But I want to emphasize that fluctuations in growth are normal and that no policy action is necessarily indicated if growth comes in somewhat above or below that outlook. When data come in outside the range expected, we need to understand the reasons and the likelihood that the departure will be sustained unless there is an offsetting policy response. Only then does it make sense to consider a policy response."

So while the Fed says its data dependent, that doesn't mean the next piece of data is likely to push them to change rates any time soon. In fact, if we take this statement at face value, it sounds like Poole's predilection is to leave rates exactly where they are until a series of data points come in which establish a direction.

Poole also drops the following statement...

"...monetary policy can affect only prices and not quantities in the long run"

... in a very matter-of-fact way. Unfortunately, too many in the financial markets don't understand the consequences of that statement. He is saying that the Fed cannot engineer real growth using monetary policy. So those who expect to see the Fed cut several times over the coming quarters should consider such statements and ask themselves whether the Fed's own words are consistent with their outlook. Even if the weak growth they predict comes to fruition, will the Fed react the way they expect?


Anonymous said...

Tom, Poole's statement is more weighty than you think:
"...monetary policy can affect only prices and not quantities in the long run."

As Keynes said, "In the long run, we are all dead." Monetary policy can provide a temporary short-term stimulus to the economy. Whether it can be done without inflationary consequences is another story.

However, I think you give the Fed too much credit. Economic weakness spreading from housing to the consumer may invert the yield curve further, since the Fed does not control long rates. Eventually the Fed will have to "catch up" with the market and cut rates.

Tom G. said...

I still think the Fed will cut once or twice in 2007. The move will be viewed as a tweak and not the start of cutting cycle.

I don't think the Fed will cut rates because the curve is inverted. The Fed was not forced to raise rates in 2001-2002 when the curve was extremely steep.