By Evelina M. Tainer, Chief Economist, Econoday
October 24, 2003

From the Treasury...
Economic indicators were sparse but market players saw plenty of action this week. The week began early (before Monday morning for domestic traders) when U.S. Treasury Secretary John Snow was quoted in the British press saying he would be "frustrated" and "concerned" if interest rates didn't rise this year. An economists' interpretation is simple: Snow is worried about economic growth. There is little doubt that an economic expansion, even one free of inflation, would lead to rising interest rates since borrowers would bid against each other for loans. But market players must have interpreted his comments from a slightly different perspective. Since presidential administrations have often been at odds with Fed policy makers, bond investors probably felt that Snow was instructing the Fed what to do. Later on Monday, Commerce Secretary Don Evans was trotted out to say that the Fed is independent and that the administration wouldn't dream of trying to dictate monetary policy. Of course not. At this point, the administration is benefiting from low interest rates, so why would they want a rising rate environment?

Keep in mind that John Snow is an economist - and thinks like one. The problem was simply in his forgetting that off-the-cuff remarks, in shorthand economic jargon, are not appropriate for public consumption. He is a Treasury Secretary after all. Parroting the old Rubin line, "A strong dollar is in the best interests of the United States" would have kept him out of trouble. Incidentally, Treasury yields jumped at least 20 basis points in early trading on Monday. But by the end of the day, the Snow flurry melted and the big move was fully retraced.

...To the Fed
Less noticed was a debate on inflation targeting between the two most recently appointed Fed governors, Ben Bernanke and Donald Kohn. Ben Bernanke is a strong proponent of inflation targeting. Many key foreign central banks, such as the Bank of Canada, use this method of directing their country's monetary policy.

The opponents of targeting, Kohn along with Greenspan, worry that it would limit policy flexibility. However, Bernanke and his followers have never said that one would ignore employment and focus only on inflation. In cases of economic recession, there is no question that policy should become more accommodative in order to help reduce the unemployment rate.

At this debate, the subject turned to "soft" inflation targeting, where in periods of weak economic growth the Fed would take stronger consideration of unemployment and economic growth than inflation. Donald Kohn acquiesced and stated that he would be more willing to reconsider inflation targeting as a monetary policy tool if the inflation target were not set in stone.

Inflation targeting, as a Fed policymaking tool, has a long way to go before all Fed officials are inclined to agree to it. However, this was the first time that the two opposing views seemed to soften, giving the appearance that a consensus is possible. Greenspan, although a bit tarnished since the stock market bubble and recession, still commands a great deal of respect. As long as he is not committed to the use of inflation targeting within the Federal Reserve, it is unlikely to become a policymaking tool. But his term as a Fed governor ends in 2006.