Hypothetical Bias

I'm teaching macro

Yep, for the first time at Appstate I'm teaching macro instead of micro. Here is my syllabus and my first macro forecast of the year: The Fed will cut the federal funds rate by 25 points at their next meeting. I use the WSJ to determine these sorts of things:

"In light of recent changes in the outlook for and the risks to growth, additional policy easing may well be necessary," Federal Reserve Chairman Ben Bernanke said in a speech yesterday, adding that the Fed stands "ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks." Mr. Bernanke said that while he and his colleagues remain vigilant about inflation -- and are keenly aware of the need to maintain the "Fed's inflation-fighting credibility" -- persistent worries about the housing market and new concerns about the U.S. employment situation point to higher risks to American consumer spending, the key driver of U.S. economic growth. His remarks suggest Fed policy makers are more likely to cut interest rates at their next meeting, Jan. 29-30, even by as much as half a percentage point.

Does the Fed Know What to Do?

It seems even the Fed doesn’t know what do to in the face of the current economic problems. Minutes from the December 11, 2007 indicate a wide range of views about the correct course of action. See for example the article in yesterday’s WSJ:

http://online.wsj.com/article/SB119982006327075329.html

The Dallas and KC Feds wanted no change in the target fed funds rate. Boston, Minneapolis, and SF wanted half point cuts. Everybody else wanted a quarter point. While the minutes suggest disagreement, we won’t know for sure the details until the transcript of the meeting is released years from now.

The uncertainty of the Fed reflects the general uncertainty in the financial markets. However, since December 11, the latest jobs report indicates an upward tick in unemployment and a continued downward trend in job creation. Seeing that unemployment/employment data are lagging indicators, it seems as if the Fed might be behind the curve somewhat in terms of preventing a slowdown in growth. Their hesitancy stems of course over the various signs of inflation (gold, oil, commodities).  Long term rates have fallen in the last few weeks, suggesting the investors are not so worried about inflation. This might suggest that the Fed has more room to be aggressive at their meeting at the end of this month.