Sunday, September 16, 2007

Beware of conventional market wisdom on monetary policy

A Reuters article by Ros Krasny entitled "Fed set to cut interest rates" accurately lays out the conventional market wisdom for how the Federal Reserve has responded to crises in the past and how that implies things will play out in the current situation. That is all well and good, but there actually isn't any reason to believe that the Fed will in fact follow such a historical script.

I would never suggest that we discount all of conventional wisdom, but we do need to account for evolution in the affairs of men. The goal of studying history is not to slavishly attempt to repeat it, but to learn from it. Besides, as Mark Twain put it, "History doesn't repeat, it rhymes."

Some people are claiming that if the Fed doesn't deliver what the market expects, stocks will "swoon." That may well be true in the very short-term, but the eventual path of stocks will be driven more by the real economy and the outlook for the real economy (as well as corporate profits.)

It will be interesting to hear what the Fed has to say on Tuesday, how the markets initially react, how the real economy plays out in the coming weeks and months, and how the markets react to how the real economy plays out.

Who knows, maybe the Fed will in fact follow the historical script, but the collection of people now at the Fed seem unlikely to do so, despite the impassioned lobbying of Wall Street "professionals."

-- Jack Krupansky

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