There’s already talk on Wall Street about the possibility of the Federal Reserve providing further monetary accommodation in response to the damage wrought by Sandy.
With
the Fed Funds target rate at zero, this could mean larger quantitative
easing asset purchases or a focus on buying different financial assets
by the Fed.
One trader even described what he thinks the Fed will do as “QE Sandy.”
If
history and economic theory are guides to Fed policy, however, those
counting on further accommodation may be in for a shock. It’s very
possible—even likely—that Sandy will mean Fed policy might be tighter
than it might have otherwise been. And that’s because Sandy’s
side-effects might well accomplish the very things that Ben Bernanke has
been hoping that his quantitative easing policy would.
The
reason why some of the guys in expensive shoes who are telecommuting
this week into Wall Street investment banks might expect further easing
is obvious. The economy has experienced a real shock, losses will be in
the as-yet-untold scores of billions. Federal and local governments will
accelerate spending to provide relief and reconstruction. Economic
activity in the Northeast has been severely disrupted. The economy
obviously needs an injection of money.
Only that may not be the way the Fed sees it.
In
the aftermath of hurricane Katrina, there were widespread expectations
that the Fed would drop its interest rate targets. Economists, who had
expected a tightening of policy before the hurricane struck, flipped to
predicting easing. The Fed funds rate began dropping in anticipation of a
falling target rate.
And then the Fed raised the target rate on September 20, 2004.
An
economics paper published three years after this episode of contrarian
Fed action explained not only why the Fed took this action—but why “the
monetary authority should raise its nominal interest rate target
following a disaster.”
Read more: http://www.cnbc.com/id/49625920
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