James Devine jdevine at popmail.lmu.edu
Thu Oct 1 09:43:47 PDT 1998

> I was also searching for an answer as to what international
>benefit a Fed rate cut might have. It suddenly occured to me that months
>ago I saw a study asking Japanese business executives what Yen level they
>though was best for the country (this was during the Yen's drop). They
>all cited a level against the dollar in the low 130's (which was a
>stronger Yen than prevailed at that time). I was confused by this and
>assumed that they had all hedged themselves into that level of exchange
>rate and didn't want to unwind postitions and get killed or something.
>Now it occurs to me how much the Japanese buy in raw materials, etc.,
>outside Japan. It could be that the increased profitability on exports is
>less important to the Japanese than keeping costs low. In an economy that
>is not expanding investment, this might be a logical stance to take.

I doubt it. Don't most of Japan's raw mats come from outside the US? if so, a falling dollar doesn't help.

> Leaving aside Japan, it also may be that for countries like Korea
>to keep up such high interest rates during a sharp downturn is too
>destabilizing, although I don't see how even a 100 basis-point move could
>help them that much. Interest rates in the more peripheral countries are
>even higher and I don't see how any reasonably foreseeable Fed rate cuts
>would help them. In fact, it seems to me that so long as the Fed is
>promising future rate cuts, liquidity will continue flowing into the U.S.
>bond market in anticipation of capital appreciation, it not interest

I think the best thing that can happen can be seen in what I sent to pen-l recently:

Tom Walker wrote:
>There seems to be a great deal of enthusiasm in Europe this morning for
>Greenspan's bold interest rate cut. The funny thing is, the U.S. federal
>reserve faces a genuine dilemma. If they cut rates sharply enough to head
>off global deflation, they would simply fuel a speculative boom in share
>prices that would probably thwart economic recovery anyway. If they don't
>cut rates or only cut them a weeny bit, they raise the spectre of deflation,
>which gets reflected in steep market drops.
>In very simple terms, THE MARKET now stands between MONETARY POLICY and the
>ECONOMY. The Fed is economically impotent precisely because share prices
>have become hypersensitive to Fed interventions. Rational expectations redux?

I wrote: What you say is basically correct, but we should be careful here. Cutting US interest rates doesn't automatically head off global deflation. All else constant, it drives the value of the dollar down, which lowers US imports from the rest of the world, making matters worse there. Currently, US imports are holding up the world.

The cut _can_ head off global deflation, perhaps, if (1) the heads of other central banks see it as a signal from Big Alan that it's okay for them to cut rates; (2) it encourages a general loosening of credit markets all over the world; and/or (3) it starts a coordinated process in which the CBs of the big capitalist countries cut rates. Thus the dollar wouldn't fall much at all, all else constant.

The rate cut may not help, though, if the capitalists in charge of making real investment decisions have pessimistic expectations, or face excessive debt, extreme unused capacity, and/or social disorder and if the housing market suffers from over-building or potential home-buyers with excessive debts and pessimistic expectations. With exchange rates staying relatively constant, the only way that lower interest rates stimulate the economy is via real investment. (The stock market boom that might result from lower rates might cause a little bit of real investment, but that would be transitory.)

By the way, it's October. In what month are major stock-market crashes most likely to occur? <<<<<

Jim Devine jdevine at popmail.lmu.edu & http://clawww.lmu.edu/Departments/ECON/jdevine.html

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