Why Isn't the Fed Pausing Right Now?
William Polley wonders why the Federal Reserve keeps raising interest rates at a steady clip:
What's the harm in pausing the rate increases? : In my last post, I asked some questions that have been occupying my mind lately. Keep the comments coming. Here's an interesting remark from Jacob at Everyone's Illusion, a relatively new blog worth adding to your blogroll.
The danger in pausing is the Fed may be running out of time. The Fed is worried about monetizing the ever growing deficit as well as oil price increases. Oil price (really gas price) inflation makes politicians do odd things, most of which are inflationary. The temptation is for more subsidies, increased payments for exploration companies, cash handouts to alternative sources, in other words more government spending.
Normally the risk of a pause would probably be minimal as it is the cumulative effect of Fed increases that matter, not any particular 25bps. Furthermore, they could always raise 50bps if things were looking like they were getting out of hand. This time there is one major difference; Greenspan is leaving.
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The Bush administration clearly values loyalty in its appointments. The new Chairman will likely start at a time where the risks of a slow down and inflation are quite high. The Republicans are facing an election in 2006 where they certainly do not need a “fed caused” recession when voters go to the polls. If you don’t think these issues will come up when Bush interviews candidates I think you are being naive.
Greenspan knows the successor will have less cover then he does.... Even if the Fed thinks 4.25% is enough (or even 4%) they run the risk of the new Chairman being forced into pausing for a few meetings and things getting out of hand. Better to raise too much (possibly) and let the new Chairman gain political favor...
It's an interesting hypothesis, that Greenspan might want to give the new Chairman the ability to pause at some point early in his tenure. It's certainly possible. The one slight problem with it is that while Bush may value loyalty, the job of Fed chair is not the same as a cabinet post. The Fed chair (indeed, any Fed governor) does not serve at the pleasure of the president.... But this much is certainly true. The tension between the Fed and Congress over the deficit is building by the day. That will be the new chair's biggest challenge.... I'll toss out this hypothesis... there will not be a pause until we know who Greenspan's replacement is...
