In a previous blog post I highlighted the absurd pretending game by leading Fed officials that interest rates are somehow something which are not affected by Fed policy, even though Fed policy like focuse on the setting of interest rates. The latest Fed official to do this are William Poole. In a panel discussion by the Western Economic Association in San Francisco this Wednesday [July 6 2005] quoted in Prudent Bear’s latest Credit Bubble Bulletin, Poole comments the issue of whether the Fed should take asset prices into consideration as well as consumer prices when determining monetary policy something which several European central banks, particularly the Bank of England and to a lesser extent also the ECB and the Swedish Riksbank, have started to do:“If I could just add to that. I absolutely agree [With Milton Friedman's rejection of that policy] .And one of the reasons I take that position – I’m really a hardliner on this. Let’s suppose that the Fed – as you would want with any good policy instrument – had perfect control over asset prices. I think it is incompatible with a market economy to have a government agency setting asset prices that are meant to allocate capital.”
News flash, Mr. Poole: Short-term debt instruments are assets. And the Fed has complete control over their prices[ i.e. short-term interest rates] and it also has very strong control over long-term interest rates and strong influence on stock prices and house prices. So if you -quite properly- reject government control over asset prices this means that you should reject the very institution you work for.
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This is probably a function of whether a Republican or a Democrat is in the White House. When it’s a Democrat, they say that the free market doesn’t work and it is necessary to interfere with it in the public interest. When it’s a Republican, they have to pretend that they’re not interfering in the market at all.
even though Fed policy like focuse on the setting of interest rates.
What does this mean?
It means what it says. That the Fed sets interest rates and that that is the way they conduct monetary policy
But Stefan, the only interest rates the Fed sets are the two discount rates (now known as the primary credit and secondary credit rates)- the rates Fed district banks charge member banks in their districts for borrowing from them. They don’t “set” any other interest rate; influence yes, but not set.
Allen, the Fed sets the Fed funds rate , which in turn for all practical purposes sets the yields of short-term debt instruments like Treasury bills.
……and therefore determines the profitability of the carry trade (loans).
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