Et tu, Dr. Angell?

8/23/07

Wayne Angell, writing on today’s (i.e., 8/23/07’s) Wall Street Journal’s opinion page, argues that the Fed ought to stop worrying about inflation so much and reduce the federal funds rate in order to counter the travails currently besetting the credit markets.

Dr. Angell is apparently convinced that the FOMC staff, after 19 years of Alan Greenspan and a year and a half of Ben Bernanke, remains a nest of perfidious Keynesians. Dr. Angell argues that the “Fed staff story line,” slavishly followed by the Bernanke Fed, is taken straight from the Phillips curve: that “excess demand for labor puts upward pressure on wage increases, increasing the cost of goods and services and leading to price increases.” Rather than continue its misguided focus on inflation, the Fed, Dr. Angell argues, ought to reduce the fed funds rate in order to permit “…Treasury yields to fall enough to encourage banks and other lenders to reach for higher returns, through assuming some risk by buying mortgages and other needed credit to finance the real economy.” Lest the reader assume that Dr. Angell is speaking only about Treasury bills, Angell goes on to say that the “…the FOMC should have been alerted to the evidence that the yield (sic) on Treasury bills, Treasury notes, and Treasury bonds were too high relative to financial assets with more risk.” Dr. Angell further argues that keeping the Fed funds rate too high will lead the market to “…assume that Treasury yields will rise—and the risk of a rush into Treasuries will resume, at the expense of real financing needs of the economy.”

Dr. Angell’s analysis is uncharacteristically wrong on a number of fronts. First, if keeping the fed funds rate too high will indeed lead the market to assume that Treasury yields will rise, why would that induce investors to rush into notes and bonds? I may not be much of a trader, but if I assumed that Treasury yields would rise, one of the last places I would put my money would be into intermediate and long term Treasuries. That is a minor point, however. If, as Dr. Angell argues, what the real economy now needs is a reduction in treasury yields in order to induce investors to assume more risk, the market has already obliged the real economy: since July 20, the yields on the 10 year, 5 year, 2 year, 6 month, and 3 month treasuries have fallen 29, 45, 55, 94, and 121 basis points respectively, decreasing the returns on safety and steepening the yield curve as well, the latter, perhaps, because the market anticipates that the Fed will follow Dr. Angell’s advice.

What Dr. Angell is prescribing is a Fed abandonment of its primary mission, keeping the price level under control, in order to bail out people who made foolish financial decisions. Perhaps Dr. Angell, who gained notoriety and admiration, certainly in these quarters, as a plain-speaking economist from the plains, has spent too much time on Wall Street and in Washington and has now joined the chorus of those self-styled free marketeers who, while cautioning the government to step aside when the working person is driven to desperation, want the Fed to pull out all the stops when bazillionaire hedge fund managers and other Wall Street operators begin to detect a whiff of discomfort.

The market is just going to have to sort out the current problems, just as it has sorted out so many problems in the past. If scores of hedge fund operators and other well-fixed financial sharpies lose their jobs, thousands of “homeowners” who had no business owning homes in the first place lose their homes, and millions of yuppies who borrowed against their McMansions in order to finance a lifestyle they felt entitled them to look down their noses at their neighbors finally have to face grim economic reality, those are the costs of economic adjustment. Capitalism without failure, as someone once said, is like Christianity without hell.