| Low on Ammo |
November 2002
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Greenspan's Risky Cut
The delight of Wall Street the day after the election stemmed largely from the announcement that the Federal Reserve's Open Market Committee decided to reduce the Fed Funds interest rate to 1.25% -- a 40 year low. Praise for the Fed and its Chairman Alan Greenspan was loud, and virtually unanimous. Not a single voice was heard against the cut, but there should have been several.
In basic economics class, students learn that the economy is like Goldilock's porridge, it can be too hot, too cold or just right. By raising or lowering interest rates, central banks can help get it just right. What everyone seems to have forgotten is that government deficits and surpluses also work on economies to the same ends.
Under Bush the Younger, the US has gone from a $200 billion or so surplus to a similarly sized deficit -- an expansionary policy if ever there was one. Now, a rate cut of half a percent to 1.25% on top of that is excessive. Worse, though, it is dangerous. Cheap money, whether brought on by fiscal or monetary policy, is supposed to push the economy forward -- but only if it sparks business to expand and consumers to consume. Right now, it looks like they won't. And that is why this rate cut was poorly timed.
We may need another jolt in the spring if the doldrums continue. But a rate cut then will put us perilously close to 0%. At that point, the Fed can only watch, as the Bank of Japan has watched for a decade, without any ammunition left.