The Fed’s Policy Easing

My quick reaction to the Fed’s shock and awe policy actions on Tuesday may be found at Forbes.com.

Prior to the FOMC’s announcement, when the entire focus of expectations was on the target Fed Funds rate, I anticipated a reduction of 50 basis points, but I didn’t think it mattered much since the Fed Funds rate was already trading below its target rate of one percent. Going all the way to a zero to quarter percent target range was a bold move in itself, but the more important part of the action was the purchase of mortgage-backed securities and agency debt and reiterating the coming help for consumer credit shortly. The FOMC clearly is willing to do whatever it can to pull us out of this dangerous financial crisis and minimize the damage of the recession.

Some commentators took the actions negatively, fearing its inflationary consequences. See Kudlow Interview. While the FOMC will have to make adjustments at some point to prevent that outcome, I don’t think there is an imminent inflationary threat. The velocity of money has obviously declined sharply, many parts of the credit system remain frozen, and banks are placing more priority on their own liquidity and capital levels than on maximizing lending. I think that disinflationary forces threatening to morph into deflation is more of a clear and present danger than inflation.

Pundits also worry about the downward pressure on the dollar in foreign exchange markets as U.S. rates decline relative to foreign rates. On the contrary, I think a more competitive dollar is needed to support domestic demand. As I’ve said before, I’m for a strong dollar, but not just yet.