## Monetary Policy Has Reached Its Limits...

Jim Hamilton on the Fed:

Econbrowser: Another 75: How much ammo is left in that fed funds gun?

Interesting reaction yesterday at the Chicago Board of Trade to the Fed's decision to reduce its target for the fed funds rate by 75 basis points to a new objective of 2.25%. On Monday, the fed funds futures contract had been anticipating an average funds rate of 1.95% for April, consistent for example with a 100 basis point cut yesterday and some weakness prior to another 25 bp cut at the April 29/30 FOMC meeting. However, after yesterday's meeting, the implied April interest rate shot up 20 basis points to 2.15%. The Fed made a big cut, and the market was surprised that it wasn't even bigger.

To put these numbers in perspective, prior to January of this year, the Fed had not made a cut as large as 75 basis points in a single move in the available 25-year history of the series. And yet now we've reached a point where we're surprised when the cut is "only" 75 basis points.

Still, I am glad to see that the Fed recognizes the need for at least this much restraint. I say that not because I am still mechanically thinking about a tradeoff between promoting real GDP growth and containing inflation. I think we are past that now. I could easily imagine this weekend's developments with Bear Stearns as only the initial carnage in what may prove to be a very bloody financial crisis. I accept the view that job 1 is to try to contain that damage.

But suppose you believe that oil over $100 a barrel is a destabilizing influence-- and I do-- and that the Fed's recent decisions on the fed funds rate are the primary reason that oil is over$100-- and I do-- and that further reductions in the Tbill rate have limited capacity to stimulate demand-- and I do. Suppose you also saw a risk that the inflation, financial uncertainty, and slide of the dollar could precipitate a run from the dollar, introducing an international currency crisis dimension to our current headaches.

Well, if you did, then even if you were very, very worried about our current financial problems-- and I am-- you would still want to draw the line somewhere, and acknowledge that there is some point beyond which lowering the fed funds rate further will do more harm than good. When we've got that rate to 2.25%, and people are telling surveyors they are expecting 4.5% inflation, we need to be open to the possibility that we've already reached such a point...

Paul Krugman on the Fed:

Liquidity trap watch: With all the furor over the possibility of a high-speed financial meltdown, it’s been easy to forget that we still have the problem of a weak real economy, and a Fed that is having a hard time getting traction.

And as I’ve pointed out before, we’re quite close to liquidity trap territory: the point at which open-market purchases of Treasury bills, the normal way monetary policy operates, don’t have any effect because the T-bill rate is near zero.

So, today’s morning update: as of 8:49, the one-month T-bill rate is 0.539, the 3-month rate 0.728.

Update: at 2:14, the 3-month rate is 0.591. That’s telling you that the flight to safety continues: rather than take the risk of lending to the private sector, investors are willing to park their money in Treasuries for a very, very low return.

I am not sure these two points of view are consistent--if we are near a liquidity trap, expected open market operations should, after all, have little impact on inflation as well as little impact on real activity. But here we have two very smart people thinking conventional monetary policy needs to be given a rest.

That's not comforting.