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Monday, March 31, 2008

Federal Reserve

For the last few months the Federal Reserve has been cutting interest rates in a bid to stave off recession and have the housing market rebound. What are the effects of the interest rate cuts? This could cause inflation to increase and no economic growth to result (stag-flation). The correct response to crisis would have been to watch inflation numbers, be an inflation fighter and the credit crunch may not have been as bad. If the credit crunch was only about interest rates then the home owners could refinance today and get out from underneath their bad loans, but that doesn’t seem to be happening (on the whole). So another problem looks like it may be effecting the housing/mortgage market. If those people with sub-prime loans are people in the lower income brackets (as expected) then an increase in the cost of the monthly mortgage would tighten spending by the group, and may in fact lead to some failure to repay. But not on the scale seen today; however, if that person’s food and fuel costs also increase then the person facing rising costs all around him/her. Food and fuel are less of a percentage as income increases but for those in the sub-prime mess they are typically the lower end of the scale and therefore have a higher percentage of food and fuel in their budget. This then asks the question; why do democracies make bad policies?
Rational ignorance and rational irrationality are to blame, and in this case the pressure of public sentiment could have lead the Federal Reserve to make some bad choices. But, another example of the public (and its representative) err is of more regulation. Today, Henry Paulson announced that the federal reserve will receive more funding and more regulation duties. The plan gives more power to the federal reserve to spy on financial institutions and all for the protection of the citizens of the world and the stability of the financial institutions. This strikes me as a problem. The Federal Reserve already had the power to fix the situation years ago (raise interest rates) and had the responsibility of stopping or easing inflation. Yet on both these counts the Federal Reserve has failed. What makes the public believe that more power and more regulation will fix the problem?
What if instead of bailing out failing banks if the federal reserve just let them fail and the market respond to the incentives? Wouldn’t that force bankers to then be less risky than they would otherwise be (with the previous knowledge that if they get into trouble they will be bailed out). Then if the federal reserve let the banks fail the economy would loss a certain amount of ability to spend (lowering the money supply, possibly) and by chance possibly raising the interest rate, and thus lowering the fears of inflation upon the economy. Also 3 or so years ago the federal reserve instead of worrying about how many jobs the “President was creating” the should have focused on the inflation aspect and pulled back a little more cutting the money supply. This could have slowed growth, but I don’t believe would have pushed us into a recession.
Another government failure appears on the horizon. Tax cuts (rebates). Every person in this here country shall receive a tax refund so long as that person is a citizen, who paid taxes last year and this year, and whom we like, and whom sink is the correct color, etc. Currently the federal reserve is pumping more into the economy (drowning the economy would be closer) and this money is lower interest rates, etc. But in a few weeks time the IRS will start sending out checks across the nation, rebate checks. Those increasing the money supply again. That means as the money from the Reserve and the money from the IRS will be hitting the consumer at about the same time. Inflation fears? Food and Fuel costs still seem to be rising and pulling inflation across the board with them. So, have we not only shot ourselves in the foot by not fighting inflation we seem to have also taken out our knee by feeding the inflation beast.

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