By Dr. Irwin Kellner, CBS MarketWatch.com Last Update: 10:32 AM ET Sep 27, 2002
NEW YORK (CBS.MW) -- While everyone was wondering this week whether the Fed would cut short-term interest rates, thus, by implication, further easing its monetary policy, the Fed itself was in the process of tightening - whether it realized it or not.
If you look at interest rates alone, monetary policy is aggressively easy. At 1.75 percent, the Fed's key federal funds rate, as everyone knows, has been hovering all this year at lows last seen at least 40 years ago.
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You have to go back even further to find the last time the Fed's discount rate, the rate it charges member banks that borrow directly from the central bank, was as low as today's 1.25 percent. Try 1948.
But there is another way to determine the posture of monetary policy, besides looking at interest rates. It is by looking at the supply of money and credit that the Fed makes available to the economy.
By this measure, the Fed has actually tightened since the middle of last year.
How do we know this? By examining the monetary base, the raw material for the money supply, and by looking at the money supply, itself. See the Fed's data on money supply.
Growth in the monetary base was as high as 14 percent in the middle of 2001; it is now little more than 2 percent.
And after expanding by as much as 13 percent last year, the M2 money supply is now growing at about half that clip.
Why has this happened? Because of one unassailable fact: The Federal Reserve can control the cost of money (interest rates), or the supply of money - but it can't do both at the same time.
If the Fed is targeting the cost of money, it has to adjust the supply of money in accordance with changes in the demand for it from the commercial banks, business, consumers and government.
If demand is falling because the economy is weak and people don't need as much money as they used to, then the Fed has to pull money out of the system, in order to maintain its interest rate target.
Once there is less money in the economy, it becomes difficult for business to raise selling prices to augment profits.
Indeed, if money is really tight, prices actually fall and you have deflation - not just in goods and services, but in the stock market as well.
Sound familiar? It should, because that's exactly what's happening in our economy today.
At the wholesale level, prices have been falling since last October. Producer prices for finished goods have declined year over year for 11 straight months, by close to 3 percent at times.
And I needn't tell regular readers of this website what the stock market has been doing during this time.
One more point to make your day: the last time the Fed thought it was easy when it was really tight was in the early 1930s.
Dr. Irwin Kellner, chief economist for CBS.MarketWatch.com, is the Weller professor of economics at Hofstra University.