Sunday, August 5, 2007

Your Move, Ben

. Sunday, August 5, 2007

Interesting article highlighting the double uncertainty surrounding the interaction between financial markets and the Fed.

Uncertainty number one: what does the future hold under different interest rates? If the Fed cuts rates this week, will this ease the credit crunch and thereby help avoid a worsening of conditions or will it send the wrong signal aand make future bubbles more likely? If the Fed stands firm, will the credit crunch work itself out quickly and without precipitating a broader slowdown, or will it continue to fester, deteriorate further, exacerbate the housing slump and slow growth? You run the Fed, so what should you do about interest rates? The decision would be a lot easier if you could predict the future.

Uncertainty number two: financial market participants are trying to guess what Bernanke will do, and these guesses shape asset values. They had good priors about Greenspan; because Bernanke is so new, markets don't have sufficient information to make good bets about what he is likely to do. Hence, perhaps one gets more volatility than one would have seen in similar circumstances under Greenspan.

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Your Move, Ben
 
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