February 5, 2001



Whose Hand Is It Anyway?

While reading the statement which accompanied the Jan 31 interest rate cut by the US Federal Reserve, I was struck by, what I perceived to be, contradictions within the rather short note.  As I have written recently in, Possible Dangers of "Pre-Emptive" Tightening, I fear the Federal Reserve, in rationalizing its policy decisions to the public, may be in danger of becoming a prisoner of its rhetoric.  I offer the following as evidence and leave it to you to decide.

Before examining the statement allow me to offer some background ideas which found the notions of economics I employ herein.  I believe in the concept of the "Invisible Hand" of Adam Smith, et. al., referred to in Book IV, Chapter II of An Inquiry into the Nature and Causes of the Wealth of Nations; "By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good."  My interpretation of this notion is that the good of society in the aggregate is often best accomplished by people looking out for themselves individually rather than by having some try to decide what is best for others.  Thus, for me at least, a well functioning economy is one where all sectors are seeking profit without help or hindrance.

Viewed from that perspective, I find the following excerpt from the Jan 31 statement confusing, "Taken together, and with inflation contained, these circumstances [i.e.  rising energy costs that continue to drain consumer purchasing power and press on business profit margins.] have called for a rapid and forceful response of monetary policy. The longer-term advances in technology and accompanying gains in productivity, however, exhibit few signs of abating and these gains, along with the lower interest rates, should support growth of the economy over time. "   As the most recent corporate reports indicate, the energy sector of the economy is evidencing rapid profit growth.  Thus, the universal, "business profit margins" appears misleading as only certain industry sectors are experiencing contracting profit margins, notably, but not exclusively, those which had previously engaged in rapid capital expenditure.  

Further, I am confused by the notion of inflation being contained while coincidentally rising energy costs are sufficient to depress consumer purchasing power.  To the extent that "longer-term advances in technology and accompanying gains in productivity", previously referred to as "structural"* in nature, "exhibit few signs of abating", these higher costs for energy should be offset by lower costs elsewhere, leaving the consumer free, at least from the perspective of costs, to spend as he/she has done in the recent past.  If this were not the case, inflation would, rather than being contained, appear to be rising, which would contradict the notion of "containment".  

Allow me to say, at this point, that I consider myself a journeyman economist.  My formal training, such as it was, consisted of Physics and Philosophy.  Thus I could easily have missed something commonly known by those with greater economic sophistication.  However, strictly from the perspective of common use of language, I read the Federal Reserve statement and 100 basis point interest rate cut over the course of January 2001 as sanctioning the monetization of higher energy prices to allow the technology assisted productivity gains, which, in any event, show little signs of abating, to raise economic output.   I am left to wonder how lowering the cost of capital will reduce the worrisome energy cost pressures or assist the "structural" productivity gains associated with technology.  

In Book II Chapter II of the aforementioned  Wealth of Nations we find, "Money, therefore, the great wheel of circulation, the great instrument of commerce, like all other instruments of trade, though it makes a part and a very valuable part of the capital, makes no part of the revenue of the society to which it belongs; and though the metal pieces of which it is composed, in the course of their annual circulation, distribute to every man the revenue which properly belongs to him, they make themselves no part of that revenue."   This makes me wonder about the possible benefits of monetizing rising energy costs rather than letting the invisible hand do its thing.  Perhaps, there are other events outside of my awareness and not covered in the statement which are influencing policy decisions.  Equally, perhaps in my ignorance, I missed something, however, given a choice between "hands" I'd take the invisible variety every day of the week, and twice on Sundays.


*"Of course, these events are not inconsistent with investment in high technology continuing to serve as an engine of strong productivity growth in the years ahead. As one might expect, the cyclical component of the growth of output per hour has slowed, but during the summer months output per hour advanced at a pace sufficiently impressive to affirm a definitely elevated underlying rate of structural productivity growth from the levels of a decade ago."   Chairman Greenspan Dec 5, 2000  [emphasis mine]

Author email   2001 Dave Lewis
Reprinted on Goldenbar with permission of the author