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[DonBart]

Pretty entertaining to read all the highly enlightened armchair quarterback criticisms of the Fed today. But so many misconceptions floating around about what is going on so here my 2 cents... First misconception is that the Fed rate cut is stimulative or inflationary. The point which is missed by this argument is that the Fed Funds rate has been and continues to be modestly restrictive even after today's 50 bps reduction. You can't look at nominal Fed rates in a vaccuum. You have to look at where they stand relative to the inflation rate which is the Real Fed Funds Rate (Fed Funds - Core Inflation Rate). There's a formula called the Taylor Rule which does a very good job of identifying what is accomodative, neutral, and restrictive in regards to Fed Funds rate. It says roughly that the Neutral Rate for Fed Funds is (Core Inflation Rate + 2%). So with current core PCE at 1.9% that says the Neutral Rate for Fed Funds is right around 4.0%, which means that the previous rate of 5.25% was quite restrictive and after todays cut is still modestly restrictive. Furthermore if Core PCE YOY continues to decline this acts as a De Facto tightening by driving the Real Fed Funds rate upwards. Now given the severe downturn in Housing market and the global financial fallout if the Fed continued to keep the Real Fed Funds rate in restrictive territory that IMHO would be bordering on gross negligence or incompetance or both. So, the 50 bps cut today was a very sound and rational move on their part and actually quite conservative and utterly defensible. IMHO they should and will likely cut the rate 2-3 more times to bring it to Neutral (4.00-4.25%) and if all goes well they will park it there. Which would be a very masterful feat by Bernanke if he pulls it off without a hitch. All the talk of hyperinflation is just not based on any sound understanding of how monetary policy works. For hyperinflation to occur the Fed would need to lower the Real Fed Funds Rate well into the accomodative zone like a nominal rate of 2% or less in the face of an economy that was growing above trend. Neither is the case here, not even close. As noted above the Real rate remains modestly restrictive and growth remains below trend and likely to decelerate due to housing drag. Aside from all the armchair hyperbole when one looks at the facts it is clear that the Fed did the right thing today and if anything has been erring on the side of conservatism. And yes yes yes we all know about high food and energy prices (bla bla bla!) but the Fed has no control over how much oil OPEC pumps or how well the Wheat harvest in Australia comes in. So, there is nothing they can do about the supply of those commodities, which means that they can't do anything it short of creating a Global Despression to crush worldwide demand for food and energy, and I'm not sure why anyone would want that outcome with the exception of the apocalyptic permabears. But thats outside the realm of market analysis and into the realm of psychoanalysis. Which leads me to wonder why there are so many Sour Grapes about today's Fed move? Is is too much uncritical acceptance of media and blogger bearish pablum that is continuously spewed forth about the Fed? Or is it anger from being on the wrong side of the market today? 0

[Data]

They're actually using the long-term nominal gdp growth rate when they try to fix a neutral range for the FFR. The long-term average is in the 5 to 6 percent range. Adding some arbitrary figure to the price indices is another admission that those indices understate inflation by several hundred basis points.

Edited by Data, 18 September 2007 - 10:25 PM.