February 3, 2004

G7 Meeting:  Americans & Europeans disagreement.  This weekend the finance ministers from the seven major industrial nations will meet in Boca Raton, Florida.  One of the main issues to be discussed is the status of the American economy, specifically the continued fall in the value of the dollar in the foreign exchange markets and the growing U.S. federal government budget deficit.

Basically the Americans and the Europeans see things very differently.  The Europeans will, most likely, argue that a concerted effort must be made to stop the slide of the dollar.  A cheaper dollar, or a rising Euro, makes it more difficult for European firms to export their goods to the U.S.  This hurts Europe’s ability to get their economy back on track.  Also, the Europeans are going to argue, the growing U.S. government budget deficit is drawing capital into the U.S. to the detriment of the rest of the world.  The rest of the world needs this capital, the Europeans will argue, to get their economies growing.  Thus, America needs to get its financial house in order, the Europeans will demand.

Which gets to the main point of Taylor’s argument.  The G7 should be concentrating on what things they can do to encourage long run economic growth.  These things include structural reforms in labor markets, tax policies, labor markets and financial markets.  These long term structural reforms have been put off for too long, Taylor will argue, and that is why the European economies are not growing.

So…what’s the result of this?  Probably nothing…unfortunately.  No agreement will be made on propping up the dollar and the Europeans will continue to put off structural reforms.  Macroeconomic policymaking sure can be confusing.

Sometimes it’s not what you do but what you say.  Last week the Federal Reserve’s Open Market Committee decided to keep interest rates unchanged.  You would think that the equity markets would respond positively to this.  Remember the stock market hates an interest rate increase.

Well…while the Fed did not raise interest rates it did change, ever so slightly, its post-meeting announcement.  At each meeting since August the committee released a statement explaining why they have kept interest rates unchanged and they stated that monetary policy would be accommodative (read non-contractionary) "for a considerable period."  Okay.

Last week the Fed changed this statement a bit, to say "The committee believes that it can be patient in removing its policy accommodation." Okay, so they said basically the same thing, right?

Not to financial markets!  Once this change in terminology was released the stock market and bond prices fell like crazy while the dollar advanced in the FX markets.  Market players believed that change in the statement was the first step in the Fed’s ultimate goal of raising interest rates.  The futures market suggested that the Fed is going to raise short term rates by a quarter of percent as soon as June.  Needless to say everyone is going to be hanging on every word Chairman Greenspan utters when he testifies before Congress on next week.

All the best,

MB