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May 16th 2005

Is the Fed misguided?

As chairman of America’s Federal Reserve Bank, Alan Greenspan is arguably the most important economic policy maker in the world. As a result, every speech he gives and every move he makes his scrutinized by analysts and economists. One particular analyst, CNBC’s Lawrence Kudlow believes Greenspan is misguided. Greenspan’s reasoning for raising interest rates 8 consecutive times is ostensibly to keep pace with rising inflation, brought on by an expanding economy. However, writes Kudlow, Greenspan might be relying on irrelevant indicators to build his forecasts for inflation. Bond yields and commodity prices, which often mirror investors’ inflation expectations, are both plummeting. Measures of the money supply, which are economically correlated with inflation, seem to suggest that inflation is insignificant. Instead, Greenspan may be predicating monetary policy on asset prices. For example, there are bubbles forming in regional real estate markets, throughout the country. Perhaps, Greenspan is raising interest rates to prevent these bubbles from further expanding. However, writes Kudlow, this reasoning is fallacious:

If he [Greenspan] is watching housing, he is looking the wrong way. The key reason behind the surge in housing investment is the shower of tax advantages on this sector since the 1997 tax bill. On a tax basis, it’s much better to invest in homes than in stocks as home-sale profits are tax-free up to $500,000.

Read More: Economy in Fed’s Hands?

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Posted by Adam Kritzer | in Politics & Policy | No Comments »

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