For at least one brief shining moment, stock markets rallied smartly Tuesday after hearing some sane monetary advice from Dallas Fed president Robert McTeer.
While many credited the jump in consumer confidence for this morning’s market rebound, the real reason for a 150 point Dow Jones lift was McTeer’s remark that “sooner or later, as the economy gathers momentum, and gets stronger, adjustment will have to be made. But, I am not in a hurry.” [Italics mine.]
McTeer also cited declining inflation, rapidly growing productivity, and significant unused capacity in an economy now just moving from recession into early recovery. Alone among FOMC members, McTeer uses real-time financial and commodity market indicators to guide his policy views. He also follows monetary trends. Most important, he does not believe in the Phillips curve trade-off between falling unemployment and rising inflation. Nor does he believe that monetary policy should set limits to the rate of economic growth.
Ever since the Fed’s last meeting a week ago, stock markets have been falling over fears of rapid-fire Fed interest-rate hikes that would drain much needed liquidity from the nascent recovery. Business debt ratios are still high, and credit availability has not yet recovered for the vast majority of U.S. firms. Therefore, stock markets correctly worry that premature Fed tightening would damage recovery prospects.
Bush economic advisor Lawrence Lindsey shares these financial worries. In an interview on CNBC’s America Now, Lindsey asserted that the $6 trillion loss in financial wealth from the stock market’s deflation generated a sizable negative shock to the economy. While Lindsey foresees economic recovery, he is quite cautious in his assessment of the future and believes that additional tax-cuts would have provided an important recovery cushion.
Both stock and bond markets are forced to deal with the reality of Phillips curve-type Fed thinking. The FOMC’s latest decision to shift their balance of risk policy assessment from recession to neutral removes any doubts that the central bank has been weaned off its Phillips curve model. The very nature of the so-called policy bias sets up the discredited trade-off
between inflation and growth. This despite the fact that even the most optimistic forecasts of a 4% recovery rate this year would still leave the economy far short of its 7% historic recovery pace.
At least on the surface it would appear that the Fed has learned little and changed little from its massive over-tightening mistake in 2000. Indeed, with personal tax rates coming down, and business tax costs on the decline from the congressional decision to legislate a 30%, 3-year cash expensing bonus for business depreciation, the Fed should be increasing liquidity to accommodate tax-induced investment gains. If inflation is defined as too much money chasing too few goods, then tax-cuts to promote additional goods should be met with monetary expansion, not restraint.
It is rumored that at least one prominent supply-side thinker is now under consideration for an open Fed seat. If so, this would be the White House’s first really solid central-bank appointment.
Meanwhile, it remains unlikely that Alan Greenspan will serve out his full term as Fed chairman through 2004. To promote non-inflationary growth and monetary reform, why not Bob McTeer?