Sunday, February 26, 2006

Why the Fed is Irrelevant

[Wow, third post this morning! I've been extremely busy, so it might be that a lot of my blogging comes on weekends in the future!]

While not all my readership seems to appreciate economics or investment postings (I've gotten e-mails from friends asking me to please cut it out) I'm still intrigued by the topic, so I guess we'll continue to have some more. I found this article by John Hussman to be quite intriguing. He's a PhD in economics, and a very interesting read if you are interested in investing. In this article, he argues that bar in the event of a banking run, the Federal Reserve is irrelevant, except for a physcological effect. This is stark contrast with media outlets and analysts obsessing about the Fed's every move. I'm no economist, so I am unable to critically evaluate the strength of his arguments, although I guess I'm a little surprised because it contrasts with the argument that the Fed has created asset bubbles with low interest rates. Some excerpts ...
One might respond that even if the Fed doesn't affect credit, surely changes in the monetary base affect inflation. But if you look at the statistical evidence, the relationship between monetary growth and inflation is very weak. Instead, our research indicates that inflation is primarily the result of growth in unproductive forms of government spending (basically defense spending, entitlements and other expenditures that fail to stimulate the supply of goods). The evidence both from the U.S. and other countries clearly demonstrates this relationship.

Except for the Federal Funds rate, the Fed does not determine short-term interest rates. Most of the time, it simply follows them. Statistically, the Federal Funds rate consistently lags market interest rates such as Treasury bill yields. Indeed, changes in market rates have far more predictive power to forecast the Federal Funds rate than vice versa.

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