Hope leads substance, however. It was interesting that all three economic indicators released Wednesday -- on three different sectors of the economy -- were preceded by a "plus" sign. New orders for durable goods, new home sales and consumer confidence all rose (the first two in May, the last one in June). While the trend, particularly in orders, isn't likely to be sustained, the hint that the economy may be stabilizing will be encouraging to the Fed -- and a warning that it may have done enough.
The Fed started easing on Jan. 3. Given that monetary policy affects the economy to a "statistically significant extent with a two-quarter lag," things should start to look better in the third quarter, says Henry Willmore, senior US economist at Barclays Capital Group.
That doesn't mean the Fed can effect an improvement in capital spending, which is Greenspan's baby, corporate profitability, which has become something of a Fed mandate, or help energy-starved California at the expense of energy-rich Texas.
Still, the policy transmission mechanism works through one key channel that, of course, everyone likes to ignore: the banks and the money supply.
When the Fed lowered the fed funds rate to 3.75 percent, real interest rates will be close to zero (using the 3.6 percent year-over-year increase in the consumer price index, not Greenspan's preferred PCE price index excluding food and energy). What that means is the Fed is offering free loans to the banks. Every profit-maximizing institution should be lining up to borrow a bundle, using the cheap credit to buy Treasury notes yielding 5.25 percent. The 150 or 175 basis-point risk-free spread (credit risk, not market risk) between borrowing and lending rates goes right to their bottom line.
And if a bank isn't doing that, its CEO should be hauled up in front of the board of directors and tarred and feathered.
A zero real interest rate is unsustainable in a growing economy for the simple reason that it will lead to an explosion in money and credit. It was this realization that impelled Greenspan to start to raise rates in early 1994, once it was clear the economic expansion was getting some legs. That was probably the last time the Fed was proactive.
I doubt the Fed will include any mention of zero real rates in its statement Wednesday because it's as interested in managing expectations as in managing the macro-economy. The last thing policy makers want to do is upset the stock market.
But I'd wager that Greenspan is cognizant of the danger of zero real rates in an expanding economy, at least. "Greenspan has always been an advocate of real-rate analysis," says Chris Low, chief economist at First Tennessee Capital Markets. "I wouldn't be surprised if he had some ultimate target."
Whether he does or doesn't, he isn't going to share it with the rest of us just yet. Still, zero real rates represent an obvious place for the Fed to pause.
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