December 13, 2007

Supply-Side Smackdown!

Two voices I esteem differ in reaction to the Fed's coordinated plan. Larry Kudlow, well, I'll let him tell you:

The Fed is blowing smoke at us, pure and simple. The only way to clear up overly tight money and the credit squeeze is to slash the federal funds rate. Or, better yet, let it float. All of this liquidity facility talk is a bunch of rigmarole.

Don't Ice it, Lar -- tell us how you feel. Meanwhile the WSJ Ed Page celebrates A Better Fed Idea:
Maybe we're finally getting somewhere. Yesterday's announcement that the Federal Reserve and four other central banks are offering a new way for banks to borrow is the kind of creative regulatory plumbing we've been waiting to see in this credit imbroglio.

While news reports described this as one more "liquidity" injection, it is important to distinguish yesterday's move from the overall monetary easing the Fed continued a day before. The latter is a blunt instrument that amounts to flooding the entire economy with dollars. It carries substantial risks for the value of the dollar and future inflation, especially the way the Fed has been so willing to respond to Wall Street pleading to cut interest rates.


I have to go with "Kuds" (as President Bush calls him) on this one. I'm not picking a favorite, but Kudlow (and Art Laffer) have been pretty eloquent on the Fed's need to address a seriously inverted yield curve. The discount rate is more than 100 basis points above the 90 day Treasury -- even after the 25 bps cut.

That said, I hope the WSJ Ed Page is right. The good news on their side is the extra liquidity that UK banks will get. I hope they're right, but I fear Larry is.

Economics and Markets Posted by John Kranz at December 13, 2007 10:04 AM

The Fed may be blowing smoke, but Kudlow is smoking something. He's as smart in person as on his show, but uh...

OVERLY TIGHT MONEY?????????

Does this look like overly tight money? And this is only M2, not MZM. The Fed doesn't dare tell us what M5 is, which coincidentally began right when we should have started to worry about its inflationary practices.
http://www.federalreserve.gov/releases/h6/Current/

Kudlow's problem is two-fold. First, he discounts (no pun intended) the dangerous expansion to the money supply; like most people, he looks almost exclusively at interest rates. Second, he uses Treasury yields as a baseline. There are so many other factors in play, and it's almost to the point that he's switching cause with effect.

Posted by: Perry Eidelbus at December 13, 2007 12:54 PM

I'll add that there's only one thing we need to let float: interest rates.

Free market proponents talk all the time about not fixing prices, to let resources be allocated by price to those who will bid most for them. Why not, then, for loanable funds? (As my Austrian professor taught me, the only truly important economic indicator is the supply of loanable funds.)

The Fed's action only encourages more borrowing in a time when borrowing conditions should be leaner. But instead, it's acting like a doctor who wants praise for applying a tourniquet, when it's the doctor who cut off your limb in the first place.

Posted by: Perry Eidelbus at December 13, 2007 1:23 PM | What do you think? [2]