Why Isn't the Fed Pausing Right Now?

William Polley wonders why the Federal Reserve keeps raising interest rates at a steady clip:

What's the harm in pausing the rate increases? : In my last post, I asked some questions that have been occupying my mind lately. Keep the comments coming. Here's an interesting remark from Jacob at Everyone's Illusion, a relatively new blog worth adding to your blogroll.

The danger in pausing is the Fed may be running out of time. The Fed is worried about monetizing the ever growing deficit as well as oil price increases. Oil price (really gas price) inflation makes politicians do odd things, most of which are inflationary. The temptation is for more subsidies, increased payments for exploration companies, cash handouts to alternative sources, in other words more government spending.

Normally the risk of a pause would probably be minimal as it is the cumulative effect of Fed increases that matter, not any particular 25bps. Furthermore, they could always raise 50bps if things were looking like they were getting out of hand. This time there is one major difference; Greenspan is leaving.

...

The Bush administration clearly values loyalty in its appointments. The new Chairman will likely start at a time where the risks of a slow down and inflation are quite high. The Republicans are facing an election in 2006 where they certainly do not need a “fed caused” recession when voters go to the polls. If you don’t think these issues will come up when Bush interviews candidates I think you are being naive.

Greenspan knows the successor will have less cover then he does.... Even if the Fed thinks 4.25% is enough (or even 4%) they run the risk of the new Chairman being forced into pausing for a few meetings and things getting out of hand. Better to raise too much (possibly) and let the new Chairman gain political favor...

It's an interesting hypothesis, that Greenspan might want to give the new Chairman the ability to pause at some point early in his tenure. It's certainly possible. The one slight problem with it is that while Bush may value loyalty, the job of Fed chair is not the same as a cabinet post. The Fed chair (indeed, any Fed governor) does not serve at the pleasure of the president.... But this much is certainly true. The tension between the Fed and Congress over the deficit is building by the day. That will be the new chair's biggest challenge.... I'll toss out this hypothesis... there will not be a pause until we know who Greenspan's replacement is...

Comments

[wkwillis]

Does the Fed even matter? The people buying Treasury paper can stop buying it and start buying commercial paper instead.
You talk about all the Federal money that is going to the property owners in the Gulf after Katrina and Rita. Is that as inflationary as the half million middle class refugees with their credit cards and no more home equity (because the value of their post hurricaine houses is less than the mortgage) or jobs are going to be as they use their credit cards to start over some place else before filing bankruptcy?
Note, I am talking about the half million predominantly white middle class evacuees, not the half million predominantly black poor evacuees without credit cards.

[George V. Reilly]

There's an unclosed italic tag at the end of this post, which affects everything below it.

[Max]

Fix the italic mark at the end of this entry! It went wild, italicizing virtually the whole page...

[kharris]

I know that a good bit of Washington policy thinking is pretty opaque, especially over the last half decade. The exception, it seems to me, is at the Fed. The Fed keeps saying it is aiming at neutral, so why do we not consider the possibility that the Fed thinks monetary policy is actually easy and that it is heading toward neutral? The Fed keeps mentioning keeping inflationary expectations contained (and in the most recent FOMC statement dropped "well" when saying inflation expectations are "contained"), so shouldn't we consider that the recent sharp rise in inflationary expectations is a considerable factor in Fed thinking? Would not a responsible Fed chairman, one with an eye to his treatment in history, not want to finish the job s/he started, regardless of the political calendar?

I don't offer this as a sort of Occam's razor argument, though it would be a good one, I think. I offer it because there argument for hiking rates, regardless of whether one agrees with the argument, is clear. Policy is thought to be stimulative, slack is being used up, growth has been trendlike for some time, fiscal policy is stimulative, there may be an asset bubble, and energy prices run the risk of spilling over into core prices. Does the prospect of handing over the chairmanship ahead of an election occupy any of Greenspan's waking hours? Problably. Is there good reason to think that prospect is driving policy? No, not when the same policy would very likely be followed even if the midterm elections were months further off than they are.

We also ought not think that the Fed is monolithic. There has been a dissent against hiking rates, and that dissent probably represents the views of more than one voting FOMC member. A considerable minority of Regional Fed Bank Boards has arrived at either 2 of 3 discount rate meetings this year wanting no rate hike. When Greenspan said in his mid-year monetary policy testimony that he'd "perceive" neutral when it arrived, maybe he meant he'd perceive neutral when the vote at the meeting is to leave rates unchanged.

[Bruce Ferguoson]

Let me try and ask this question. In 2001 people were concerned about deflation. Since then people have commented on the inflationary nature of deficit spending. Now in light of the fact that the deflation has become inflationary, and given the fact that the hurricane will most likely cause even more deficit spending, why would the Fed not continue to raise rates?

[howard]

my guess is that greenspan's replacement will be...greenspan.

for one year.

because the very, very, very last thing that bush and the gop need in 2006 is the market freaking out over yet another terrible bush appointment when the job of the appointee is to replace greenspan....

[bakho]

Greenspan: "We have lost control of the budget."

What more needs to be said?

[JAV]

wanted to see if this fixed the italics :)

[marquer]

Sigh. It appears that, as of this writing, I shall have to reconcile myself to appearing italicized.

In any event, the issue of the Greenspan succession can be reduced to a single primary issue.

Greenspan's predecessor at the Fed, Paul Volcker, did Alan the signal favor of absorbing the worst of the pain required to quell the late-Seventies inflation during Volcker's own tenure.

A lot of Greenspan's legend for having providing relatively low-inflation growth would lose its luster if it were more widely noted that he had been given the helm, by Volcker, of a ship which had been righted, pumped out and which had had its steerage way restored.

Will Greenspan do his successor the favor which was done for him? In a pig's eye. AG is going to give the next Fed chairman the equivalent of a perfect storm to deal with. Greenspan has shown absolutely no inclination to use his bully pulpit to force necessary reforms in critical areas such as US fiscal policy. Which implies that the poor sap who is next in the Chairman's seat is going to have to do that ugly job, and will have to do so while relatively new to the position, without having built up the credibility which Greenspan presently enjoys.

I have a friend who insists that Greenspan is still a radical Rand disciple at heart, and that AG has been plotting for forty years to collapse the walls of US big government and state capitalism by inducing a massive unrecoverable crisis of spending and debt. Judging by actions alone, it's difficult to refute his case.

[Movie Guy]

"Why Isn't the Fed Pausing Right Now?"

Brad, I would prefer to read your answer.

MG

[glenn hefner]

I think the fed needs more room, with rates so low, they have few bullets to respond to the next recession or two, and those are liable to be real bad. Soooo, it's best to get the reates up now, even if they have to cut, say, in 12 months' time or so.

[spencer]

From the White house perspective the most importaqnt thing in the new fed chairman is that he will not critize their fiscal policy.

So maybe we should watch for a real dark horse candidate like, maybe, Phil Gramm.

[anne]

Spencer:

"From the White house perspective the most importaqnt thing in the new fed chairman is that he will not critize their fiscal policy."

Precisely so, and there are many loyalists from whom to draw.

[Stormy]

Excellent point, glenn.

With interest rates low and a recession looming, how will the pumped be primed? The Fed simply cannot jack the rates up fast enough.

[Charles]

I was actually heartened to see Greenspan saying out loud that spending has outstripped tax receipts to the point that disaster looms. Raising rates may be futile, or even counterproductive from the standpoint of what would happen in an ideal world.

This is not an ideal world.

People who do what they can get points for trying.