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Thursday, September 20, 2007

Emily Litella as a Central Banker: "Never mind"

by Calculated Risk on 9/20/2007 09:55:00 PM

Floyd Norris writes at the NY Times: Inside the Mind of the Fed

Six weeks ago, the Federal Reserve thought the American economy would easily weather problems in the credit market. One week ago, the Bank of England warned against the risks of bailing out those who had made risky loans.

This was a week to say “never mind.”
Norris notes that the Fed and the BoE changed course, but ...
By yesterday ... the markets were moving in ways that cannot have made the Fed happy. The dollar fell — an expected result from cutting short-term interest rates — but long-term rates rose, and so did mortgage rates.

“Alan Greenspan’s conundrum is becoming Ben Bernanke’s calamity,” said Robert Barbera, the chief economist of ITG, recalling that when the Fed raised short-term rates under Mr. Greenspan, long-term rates did not follow. Now the opposite is happening, a fact that will make it that much harder to stimulate the economy.
This was my concern when I outlined a possible vicious cycle that could occur as the Fed cut rates: Watch Long Rates.

Norris goes on to highlight two recent Fed papers that we've discussed before:
Those wanting to understand the Fed’s reversal can profit from reading two papers by Fed officials, released this summer as the credit squeeze was worsening.

In total, they constitute an admission that the Fed was surprised by the housing and borrowing boom on the upside, and now fears it will be surprised on the downside.
emphasis added