Share this story
Close X
Switch to Desktop Site

Fed Should Ease Reins

THE Federal Reserve System is taking a major risk of causing a sizable recession. It has allowed the growth of money - the fuel for the economy - to plunge to an extremely low rate, ``hardly visible to the naked eye,'' writes James Grant, publisher of a market newsletter. A narrow measure of money, known as M-1, has been declining at a 5.1 percent annual rate in the past three months. It grew a miniscule 0.8 percent over the past 12 months. A broader measure known as M-2 has grown at only a 1.2 percent annual rate in the same three months and by 2.7 percent over 12 months. These numbers are at levels that have been followed by serious slumps in the past.

The Fed, of course, has been tight on money in order to restrain inflation. The consumer price index soared ahead at a 6.7 percent annual rate in the first five months of this year. But the economy has already slowed decidedly, a fact which should put the brakes on inflation.

About these ads

Indeed, a few economists suspect the economy has already slipped into a recession. That's not yet the majority view of economists. As for the Fed, it has eased ever so slightly on interest rates. Market interest rates have fallen by roughly 1 percent in the past two months. The Fed has allowed the federal funds rate, which it controls tightly, to decline by about 3/8ths of 1 percent.

However, monetary history indicates that once the economy starts to slow, the doldrums alone will bring down interest rates further. The Fed must actively move to increase the money supply to properly counter any recessionary tendencies.

The policymaking body of the Fed, its Open Market Committee (FOMC), met July 5 and 6. There will be no direct announcement of any decisions by this body, composed of seven Fed governors and 12 presidents of regional Fed branches, five of whom vote at any given time. If the FOMC has decided to loosen up on the monetary reins, that will become known when the Fed allows the Federal funds rate to drop further or if it announces a reduction in the discount rate it charges on loans to commercial banks.

Because of the lag between Fed actions and their impact on actual economic activity - a lag that tends to run around nine months - any policy change now won't quickly bring a halt to the slowdown. But immediate action could at least prevent a slump from deepening. The nation can afford a ``soft landing'' of the economy. A hard landing, though, would bump up the federal deficit, boost unemployment, push some over-leveraged corporations and financial institutions into bankruptcy, and make it more difficult for debtor nations to export to the US and earn the dollars that enable them to service their debts.

It would be better for the Fed to lower the risk of real trouble by moving quickly toward monetary easement.

Follow Stories Like This
Get the Monitor stories you care about delivered to your inbox.