Re: Let them eat fed

[Jim Devine <jdevine@xxxxxxxxxxxxxxx>]

Tom asked:
> 1. What is the meaning of this 1/2 point fed rate cut, 4 weeks ahead of
> schedule and the euphoric stock market response?

It may mean that Greenspan shares the intuitive feeling that the US economy
is currently going into a steep recession that I and many others have, and
that it's following the advice that pen-l's Brad deLong gave (cut rates
_now_ to atone for the cold bath that the year of rate hikes caused). It
also fits with a good story on Greenspan by William Greider in the NATION
(01/01/01), which suggested that AG has been expansionary in the past
because of fears of deflation -- and we might just well be facing
deflation, which is crucial given the way in which the US private sector
has accumulated debt. Debt deflation is deadly.

Or maybe AG wants to present a gift to George W. or undermine the demand
for tax cuts or both. Or maybe he wants to show us who's in charge.

As for the stock market's response, that's normal speculator behavior,
which of course gets the most emphasis in the Reuters news story at Yahoo.

> 2. Why is the fed "always right"?

(a) because it has the best information; and (b) the victors always write
the history.

> 3. Is there a danger that over reaction in financial markets could
> undermine the impact of the rate cut on the real economy?

It's possible that a re-expansion of the speculative bubble could drain
funds away from other sectors. That feels unlikely.

> 4. Do interest rate cuts and/or increases always have direct linear
> effects on economic activity or might they, under some circumstances lead
> to perverse consequences?

No direct linear effect. When there's a lot of unused industrial capacity,
corporate debt, and/or  pessimistic expectations or households are saddled
with too much debt, interest rate cuts encourage re-financing more than new
spending and recovery.

Further,  rate cuts might encourage further speculative accumulation of
debt, making future imbalances -- and thus a future recession -- worse. On
top of that, the rate cut might cause the dollar's value to fall dramatically.

> 5. Why did the US dollar strengthen in response to the rate cut?

speculation? I don't think the dollar strengthened much or will stay strong
for long.

> 6. What does "hair of the dog that bit you" mean?

I don't know the context. But supposedly, if one has a hangover, drinking
some of the liquor that caused it will reduce it.

Jim Devine jdevine@xxxxxxx &  http://bellarmine.lmu.edu/~jdevine