Fed starts policy meeting, no rate change seen Fed starts policy meeting, no rate change seen
“The Federal Reserve’s policy panel began meeting Tuesday morning with economists expecting the central bank to leave short-term interest rates unchanged but signal it sees inflation as a potential worry.”

And here’s the real problem. Instead of a small move now, the Fed will wait until inflation really gets rolling and then do 12 or 13 rate hikes of 25 to 50 basis points. Instead of 2 or 3 1/4 point hikes in 1998, they created a recession with a big string of big rate hikes. Then, instead of responding quickly with some small rate cuts as soon as they burst the stock market bubble, destroying a couple trillion dollars in paper wealth with the predictable effect on the economy, they waited and then did a big series of big cuts. Of course, the stock market bubble situation could have been dealt with in a much more targeted way with a series of gradual increases in margin requirements. I don’t have empirical data on this, but just for example, a series of 10 monthly 1 percent increases in margin requirements would have had a slow but direct effect of slowing the “irrational exuberance” without sending the market into “irrational despondence.”

Letting markets set rates seems like the obvious solution, but truly letting markets set rates of course means that the government can’t be the single biggest debtor in the world. Given the way our fiat money system works, there isn’t going to be a true ‘market’ rate unaffected by government action. Even the effects of things like military action on interest rates are amplified when government is the biggest borrower and the money supply is backed not by a commodity but by bonds. (Which are a promise to pay money backed by bonds……I’m afraid I’ll never really understand that setup.)

Given the reality of the system, the Fed needs to set a much narrower target rate range and stay there. If they feel inflation is starting to be a problem, a quick but moderate response would be a lot less disruptive to markets. Once inflation begins to relax, they can reduce rates. And if their rate increases cause a small contraction, it should be small and easily corrected.

Of course the real irony is that a semi-Objectivist would be micromanaging the economy this way in the first place. The idea of setting a target rate thta preserves the integrity of the dollar and staying in a narrow band certainly seems a lot more in keeping with what Greenspan claims to believe.

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