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Fed refuses to print money Original Source Link: (May no longer be active)
http://www.kansascity.com/mld/kansascity/business/6179337.htmhttp://www.kansascity.com/mld/kansascity/business/6179337.htm
Posted on Fri, Jun. 27, 2003
Fed can fix economy with cash
By LARRY KUDLOW
Columnist
On the day after a somewhat confusing action by the Federal Reserve -- an inside-the-box, quarter-point cut of the overnight interest rate -- most of the stock market action was positive.
On Wednesday, the day the Fed announced it had lowered the federal funds rate by 25 basis points to 1 percent, stocks fell. But Thursday they recovered.
Information technology led the way, a sign of rising economic expectations. Health care came in second, suggesting that investors were still not frightened by Congress' attempts at Medicare reform. Financials also led the way higher.
Treasury bonds, however, got whacked again. The bellwether 10-year note climbed all the way to a yield of 3.5 percent. Only 10 days ago, it was about 3 percent.
Some of this sell-off reflects disappointment that the Fed did not launch a shock-and-awe liquidity-adding program, like the one Alan Greenspan recently floated when he said the central bank might start to buy 10-year bonds. This move would have given the Fed one more way to pump new cash into the pipeline.
But some of the bond sell-off could also reflect improving growth expectations as the Fed continues to be accommodative.
We needed shock-and-awe-level accommodation on Wednesday -- in the form of a 50-basis-point cut or a liquidity-adding policy shift away from the Fed's ongoing interest rate targeting. But the fact remains that the 25-basis-point cut of the funds rate represents a 20 percent easing.
While overall monetary trends remain disappointing, with no clear sign that we are well into reflationary territory, the monetary base over the past two months has increased by an 11.5 percent annual rate. If the Fed keeps this rate of liquidity expansion going for another six months, it will surely help to wipe out any deflationary threats. This new cash would also help finance the largest investment-oriented tax cut in decades.
Transaction demands in a rising economy -- including the investment tax incentives and a new spate of Wall Street deal-making -- must be accommodated by the Fed. So perhaps the Fed's latest rate cut will be associated with a significant liquidity buildup. Perhaps there will be a continuation of rapid monetary-base growth.
But these are not certainties. Once again, the Fed has left everybody guessing.
Oddly, coverage of the Fed's latest move in The Wall Street Journal, The New York Times and The Washington Post never mentioned the word money. And it's the creation or destruction of money that is the Fed's primary job.
It was too much money chasing too few goods that caused the inflation of the 1970s, and too little money in relation to the availability of goods that has caused the deflation of the last few years.
Newspaper writers are blaming deflation on subpar economic growth, and they say the lagging economy has created a growing "output gap" between potential and actual activity. But we learned painfully in the 1970s that inflation can coexist with recession -- known as stagflation.
Then came Reagan administration advisers Arthur Laffer and Robert Mundell. They argued for monetary restraint as a cure for inflation and significantly lower tax rates to produce an economic recovery. This supply-side mix is just as important today. The cure for deflation is monetary expansion. And yes, the recipe for economic growth centers on more tax rate reduction.
This week's action by the Fed seems to suggest that they will not be raising their target interest rate for a long time. This should mean that open market operations will keep the money spigots wide open. If so, this is very good news.
President Bush has sponsored a huge tax cut. The Fed must support it. It must keep showing us the money.
Larry Kudlow is co-host of CNBC's "Kudlow & Cramer." His column appears on Fridays.
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