Tuesday, January 22, 2008

Rate Cuts and You

Mike asks how the rate cuts will help the common man. In some ways this question cuts to the heart of monetary theory and policy. In principle the sole purpose of monetary policy should be to help the common man. Is that whats going on now.

Yes, and no. Its very very tempting for the monetary authority to focus heavily on assets prices and as such the upper class. You get instant feedback about expectations, liquidity, and overall wealth by looking a equity and credit markets.

To find out whats happening to the Joe on the street takes years and even then we are often not sure if we have the right metrics. Moreover, Wall Street is often clamoring for help while the Joe Sixpack may not even know what the Fed is.

However, cuts (and hikes) do wind up having their biggest effect on the weakest members of society.

Why?

Because, those members are the most vulnerable to inflation and unemployment. When the Fed cuts now the hope is threefold.

1) This will lead to more favorable mortgage and credit card rates which will relieve the payment stress on average consumers

2) That if consumers can slowly, rather than dramatically reduce spending growth (as they must) then businesses can adjust without resorting to mass layoffs.

3) That we can ease pressure on the banking system so that more people and businesses will be able to get credit when they need it.

All of these things should ease the stress on the common man. The reason I did not believe we would have cuts this morning and some economists are upset about them is because it looked as if the Fed was going to far to stem losses in financial markets.

This is a really hard call because losses in financial markets can lead to pains for the average worker if it means that corporations have a hard time raising capital and need to instead turn to layoffs.

At the same time, however, more vulnerable Americans who have relatively fixed incomes are susceptible to inflation and there is some evidence that inflation causes the entire system to be sluggish. Not to mention the problem of encouraging financial speculators to take risks if they believe the Fed will bail them out.

So, the upshot is that the cuts should reduce some stresses on average people and hopefully reduce painful layoffs.

15 comments:

Mike said...

So this isn't a catering to Wall Street? Aren't they just delaying the inevitable? This can't be good for the dollar or inflation.

How come the ECB is more concerned with inflation than the Fed?

dWj said...

I think the timing of today's cut was more Wall-Street--driven than the fact of it. The real data were sufficient to justify a 50 to 75 bp cut; if they cut another 50 next week I'll believe a bit more in market-pandering.

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