Financial Daily from THE HINDU group of publications
Wednesday, Nov 30, 2005
Financial Daily from THE HINDU group of publications Wednesday, Nov 30, 2005 |
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Money & Banking
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Monetary Policy Columns - Financial Scan US monetary policy: Discretion vs valour? S. Balakrishnan
MR BEN Bernanke is damned if he does and damned if he doesn't. If the Federal Open Market Committee (FOMC) — the forum which decides the American monetary policy — does raise interest rates at his first meeting after taking over as Chairman of the US Federal Reserve, he risks slowing an economy that is already showing signs of tiredness, especially in the housing sector, which, thus far, has been the driving force. A no-change first meeting, on the other hand, may well expose him to the charge that he will be a `softie' when it comes to inflation. Succeeding Mr Alan Greenspan was probably the dream of many top economists, but heading the most powerful central bank in the world is no bed of roses. It is not the best of times for central bankers. (Has there ever been one?) The US economy is moderating and the housing market seems to be cooling. There was the real fear of a real estate crash with major repercussions for the economy. Households are in a highly leveraged position. The boom in property prices has led to equity withdrawal (borrowing against higher capital values for further property acquisitions or consumption spending). But a precipitate fall has the potential of excessively stressing the financial system and, in due course, the real economy. The trade deficit continues at `unsustainable' levels, posing a serious threat to the dollar and the possibility of an investment `strike' by foreigners, who have thus far willingly financed the gap. On the other side are the worrying indicators on inflation. After a long hiatus, gold has pushed past $500. Is it a harbinger of the bad news of more inflation? So far, it seems price pressures are restricted to energy and commodities, and have not become broad-based. But there is always the argument about pre-emptive strikes vs a policy of waiting to strike when it comes to battling inflation. If wrong, the cost of pre-emptive actions can be significant in terms of lost output and jobs. At least in the past decade, the global economy has seen little inflation. The monopolies and oligopolies of the seventies and eightiesare history. For them, pricing was no big deal — calculate costs and add a margin. If costs increased, pass them on to customers. Labour was powerful and wage settlements routinely pushed up costs and prices, and set a spiral in motion. Today nimble-footedness is the name of the game. Rising costs are absorbed by better productivity. Competition, not costs, drives prices. Much of the work of a central bank is now done by the market. No one knew this more than Mr Greenspan. Hence his opposition to non-discretionary monetary policy based on inflation targets. He thinks inflation forces are weak and, if they do surface, can be quickly brought to heel without loss of time and damage, given the speed of response of modern financial markets and business. Still, Mr Bernanke's approach of inflation targeting is bound to evoke debate. What should be that magic number or is it a range? Will it be a backward or forward-looking or concurrent target? Do we measure broad or narrow inflation? Interesting controversies lie ahead.
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