Wednesday, March 16, 2011

Kelly Evans On The Fed & Oil Prices

Monday's Wall Street Journal had an Ahead of the Tape column by Kelly Evans entitled The Federal Reserve Faces an Oil Dilemma.

In her piece, Evans offered the pros and cons of the Fed's prospective sterilization of oil's price increases. She dutifully trotted out the usual arguments involving effective taxation, consumer spending consequences, QE2, monetary easing and how all of these effects might relate to US economic growth.

What I found odd was that Evans, who is typically very well-versed in both economics and business, completely missed the obvious point.

That is, the Fed's primary job remains dollar price stability. In reality, it really shouldn't be so overly-concerned with adjusting for oil's price, or the various follow-on effects on the US economy. Rather, by maintaining stable prices, in dollars, given supply and demand forces, and money supply growth in concert with some variant of the Taylor Rule, the Fed can provide at least one fairly consistent, if not constant, in an otherwise rapidly-changing economic landscape.

In truth, the Fed isn't going to 'get it right' if it really tries to solve all the simultaneous equations which are theoretically required to arrive at the correct, perfect economic policy prescription for the US economy.

The fact is, despite the Fed or Congress, the US economy, like all economies, must suffer through cycles. And that includes slowdowns and recessions.

The Fed can mitigate (monetary) inflation, and the US economy may still experience rises in the prices of some goods due to demand-supply imbalances. When I learned economics, we called that a price signal. If prices rise, some demand ebbs, while more supply is coaxed into the market, and others seek to replace the goods, the price rises of which have provided opportunities.

To suggest that the Fed can somehow, with just one monetary lever, sterilize the effects of so many disparate inputs to our economic system is laughable. And wrong.

I'm surprise Evans didn't go that route in her column. It would have been more helpful than writing in such a way as to suggest that the Fed has choices which include actually resolving these conflicting economic forces in some perfect or preferred manner beyond simply maintaining price stability.

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