June 03, 2003
Leaning Over Backward
Alan Greenspan promises to "lean over backward" to fight deflation:
Posted by DeLong at June 3, 2003 09:01 PM
WSJ.com - U.S. and Europe Indicate
Rates May Be Cut Soon: The chiefs of the world's largest central banks -- Federal Reserve Chairman Alan Greenspan and his European counterpart, Wim Duisenberg -- signaled that they are contemplating interest-rate cuts soon, moves that could help stimulate sluggish economies on both sides of the Atlantic and reduce the risk of global deflation.
Mr. Greenspan, speaking via satellite from Washington, emphasized the importance of keeping the U.S. from sliding into deflation while acknowledging that there is still little evidence of the economic rebound he has been expecting. Though deflation, or generally declining prices, is unlikely, he said the Fed will "lean over backwards" to prevent it and the issue will be "discussed in detail" when Fed policy makers meet June 24 and 25.
The Fed chief's remarks placed more emphasis on the lack of upbeat economic data and more on the need to act pre-emptively against deflation than when he spoke to Congress two weeks ago. That suggests that the door has opened wider to a cut in the Fed's target for its key short-term interest rate, now at a 42-year low of 1.25%...
Perhaps, then, the recent stock-market runup has been based more than a little bit on wishful thinking?
People seem to have been picking out good economic news and ignoring the bad.
Maybe he's tired of bending over forwards for the current administration.
Just when I thought the bond market had topped out...
The big news is that the ECB may also lower interest rates. The weak U.S. demand growth is matched by weak world demand growth, which has been in part due to the lack of European monetary stimulus. Given the EU constraints on the use of fiscal policy, ECB's lowering of interest rates is no overdue.
My guess is that the lowering of interest rates by the European Central Bank will prove too little too late. Germany is surely in recession and close close close to deflation. Netherlands and Italy have had a quarter of negative growth. France barely grew last quarter, and seems to be going negative this quarter.
There are two ways to read a financial market event. One is to turn away from any source of market prices, concentrate on the event and figure out its implications. The other is to think about what the event might mean, then take a gander at prices and see if you want to rethink your view. The WSJ assessment may be of the latter sort. Lehman economist Drew Matus heard Greenspan's comments and told a reporter "we think this lowers the odds of a rate cut at the June meeting." Later, he concluded that "On the face of it, his (Greenspan's) comments would seem to lessen the oods of a cut, but you have to note that whenever the two-year hield breaks the funds rate, it's been a pretty reliable omen of an easing ... the market's forcing the Fed to follow." Nomura's head bond trader, Vincent Verterano, noted that "every time you hear a Fed governor talk, they mention a slight chance of deflation, but you always here the word" which is, he suspects why there is so much focus on a risk that Greenspan says is slight. As to an ease in June, Verterano's view is "that's not outside the realm of possibility. I just don't think they're going to do it right now." John Roberts, head of govvie trading at Barclay's Capital, says "Greenspan also said deflation is unlikely, but it seems the market doesn't want to hear that."
I read Greenspan's testimony. He said all aspects seem to be in place for growth, though it may not match some estimates in Q3. He said recent data suggest a "marked turnaround" and he expects further help from the latest tax cut. He called the labor market weak, but anticipates improvement when demand picks up, which he says it will. He differentiated between simple deflation and "corrosive deflation" - only the latter is a Fed concern. Perhaps the strongest hint that an ease may be in the offing is that Greenspan noted the very low cost of taking out insurance against deflation. Initial web-based press coverage took note of Greenspan's fairly optimistic tone. By the end of the day, the Treasury rally led to things like the WSJ piece. McTeer came out today sounding pretty upbeat, and mentioned in a WSJ editorial that focusing policy on employment would lead to a fall-off in productivity - a bad think in his view.
Perhaps a bit of caution toward all this easing talk is in order.