Mervyn and the MPC do not inspire much confidence, but I would rather those jokers running monetary policy than Bernanke and the Fed.
US monetary policy is in a mess. Since August, US interest rates have been foolishly chasing after growth. At the same time, the Fed poured out huge amounts of liquidity as it vainly tried to prevent troubled banks from facing up to the consequences of years of bad lending policies. In the process, the Fed has disregarded the growing dangers of inflation.
Unfortunately, the Fed is on the fast track to failureville; the economy is moving decisively into recession, the banks are still posting huge losses, while inflation continues to pick up.
Events over the last couple of days have highlighted the Fed's difficulties. As concerns about a slowdown have increased, the Fed chairman promised Wall Street that he would rates aggressively should the US economy moves into recession.
Wall Street were happy to hear about this relaxed attitude about future rate policy. Nevertheless, large investment banks are still posting massive losses. Merrill Lynch is about to write down $15 billion, Citigroup and Merrill Lynch are set to report losses of as much as $26 billion. The magnitude of the losses are so great that US investment banks have been obliged to go "cap in hand" to various sovereign wealth funds for a bail-out. This frantic overseas search for cash is a humiliation for the once proud US investment banking community.
Today, the US commerce department added to the Fed's troubles. It reminded Bernanke and the FOMC that US inflation is rising at an uncomfortable rate. In 2007, import prices increased at their fastest pace for 25 years. The commerce department then followed up with another another grim statistic. Higher import prices data pushed the November US trade deficit to its highest level in 14 months.
This latter news must have been hard to swallow for the Fed, who had allowed the dollar to crash in the hope that the US external deficit might improve. Like so many of the America's economic difficulties, the root of the US external deficit problem lay in the housing market. On the back of record house price growth, the US consumer went on a massive import spendfest. The crashing dollar has only served to increase import prices, but done little to improve the deficit. US households just kept on buying imports despite the falling dollar.
The immediate future looks rather bleak. Inflation is above 4 percent and rising. Any further interest rate reductions will weaken the dollar and add to inflationary pressures. The housing market is still sliding and pushing the economy into a recession. The current account deficit remains huge despite a massive dollar depreciation.
A modest slowdown in growth might help resolve some of these difficulties, particularly the huge US current account deficit and rising inflation. Lower growth would reduce import demand, while a slightly higher unemployment might help curb prices. However, the Fed wants to sustain growth and seems prepared to let inflation go where it likes.
It is a very short sighted strategy. Once inflation picks up, it does not fall quickly or without a significant tightening of interest rates. US inflation is already over 4 percent, with the dollar remaining weak, and rates falling fast, it wouldn't take much for inflation to climb to 6 percent. Once it is at 6 percent, a 10 percent rate doesn't seem so far away.
Back here on the other side of the Atlantic, the MPC have not yet adopted this irresponsible approach to monetary policy. So far, we have had just one interest rate cut, while the level of rates remains significantly higher than in the US.
I would like to think that the MPC could look at the Fed's difficulties and revolve to avoid the simple mistakes that Benanke and the Fed have made. Those lessons would include don't get carried away with loose monetary policy; don't let the exchange rate crash, and don't be too afraid of a modest slowdown in economic growth since a few lost points of GDP today might prevent stagflation a year from now.
Ben or Mervyn, it is not much of a choice, I admit, but I know which one I would choose.