Monetary Policy

As most know, the Federal Open Market Comm. meets
tomorrow to decide on interest rate policy. Most Fed
watchers are looking for the FOMC to cut the FFR%,
although there is less of a consensus of by how much.

The time honored indicators that have made it relatively
easy to surmise the direction of policy over the years
may count for less with the Bernanke Fed. Those indicators
described a weakening of manufacturing and capacity
utilization in late 2006, and signaled a FFR% cut for
Jan., 2007. The Fed passed over that signal and kept the
rate at 5.25%. As you will recall, Mr. Greenspan quickly
followed with mention that the odds of recession for the
US in 2007 had risen to one in three. The economy did
rebound over Q 2 of this year, and now the same indicators
imply it is too soon to cut the FFR%.

The Street and many name economists are putting substantial
pressure on the Fed to follow up on the recent cut to the
discount rate with a cut to the FFR% in the hope that it will
further ease credit crunch conditions for weaker credits and
preserve the economic expansion. Within the technical domain
of money and credit, there is an issue of whether there is
sufficient liquidity in the short run to fund a growing economy
properly. This may be only a transitory matter, but it goes to
the heart of the uncertainty Bernanke says the FOMC faces.
Moreover, the speculative run ups in gold and oil along with a
weakening dollar in the forex arena are all signaling a
deterioration in the inflation environment should the Fed follow
through with rate cuts.

We'll see soon enough what the Fed intends. For the short run,
my suggestions for the Fed would be to cut the FFR% by well more
than a slim 25 basis points if They deem a cut is needed, and to
not fear reversing course within a few months if inflation
pressures materialize. Trying too hard to mimimize volatility
in short rates and in the economy creates unnecessary volatility
in the liquidity data and may be inappropriate for an economy
that is bound to be more volatile anyway now that inflation
pressures are showing up more often.