Money Supply

Despite the recent correction to the falling prices and rising yields of U.S. treasuries, I've been wondering how the Federal Reserve might react in the coming months as the bond market remains jittery. The talk to beat inflation was tough when the new chair took his place. However, if money is tightened to reduce inflation, interest rates will have to rise even more, furthering the slump in the housing market already suffering from the recent subprime melt-down. This course of action will lead to serious unhappiness among those owning property. If the Fed decides on merely talking about beating the inflation while letting money loose, interest rates will remain less volatile and inflation will rise but perhaps at a slower rate than would cause a shock. If I were to bet, I would bet that the Fed will choose the latter coure of action. It is the politically "prudent" course although many who earn wages and have little property to own may suffer more than others.
Comments:

I tend to agree with you and this blog entry that, in the short term, the Fed will act cautiously until the economy tips decisively one way or the other, letting inflation run up a bit more. But the natural inclination for the Fed should be tighten, because if they give up the "tough on inflation" stance (already somewhat compromised by the money supply figures), they don't have anything to fall back onto. I'm sure the right course of action will become clear in hindsight. :-)

Posted by Roberto Chinnici on June 14, 2007 at 11:07 AM PDT #

Here's another way to look at it, from a different perspective altogether ...

If they fight inflation too hard, interest rates will go higher, more adjustable rate mortgages will go into default, and fewer people will be able to afford a first home. If they don't fight inflation, adjustable rate mortgages do not need to go up too high. Instead, salaries will eventually go higher with inflation (there's always a delay with salaries) ... but this course of action devalues outstanding debt. In other words, those who have given their money into debt will be earning lower, real interest rates (real interest rate = nominal interest rate minus inflation rate) ...

So, they need to side either with people that owe (mortgages or other debt) and let inflation rise or with those who lend and let interest rates rise.

As you note, we'll know in hindsight!

Posted by M. Mortazavi on June 14, 2007 at 03:18 PM PDT #

I agree with you

Posted by autooo on June 18, 2007 at 07:08 PM PDT #

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