March 31, 2005

 The Talkative Fed.  Central bankers, generally a serious, dull lot, have never been known as chatty Patties.  That all might be changing.  In a series of recent speeches and articles Fed Governor Ben Bernanke has been explaining that the Fed is trying to “talk” more about what it is doing with monetary policy. 

The goal of this “talking” is two fold.  First, the Fed wants to show that it is transparent in its operation of monetary policy.  This transparency is important so that changes in the Fed Funds target or the discount rate do not cause shocks in financial markets.  Second, and perhaps even more important, the Fed wants to use its talk to impact long term interest rates. 

It is this second goal that bears watching.  Traditionally, the Fed’s monetary policy has focused on changes in its Fed Funds target and/or the Discount Rate.  These policy changes have a significant impact on market determined short term interest rates.  The impact of Fed policy changes on longer term rates was usually a secondary effect.  Thus, monetary policy changes did, eventually, in a round about way, change longer term interest rates, including things like mortgage rates but only in a very indirect way.

Bernanke and the Fed in general, are suggesting things are going to change.  In addition to targeting short term rates, it now appears that the Fed may, in some ways, also be targeting longer term rates.  The tool to changes these longer term rates, will (for now) not be market intervention, but rather it will be the “Fed talk.”

The logic is that the Fed talk will help the financial markets predict future short term rates which then in turn helps them to correctly price long term bonds.  Therefore by manipulating market expectations the Fed can manipulate long term bond rates.

What this boils down to is we have to watch the Fed even more closely.  Not just their actions but also what they say, how they say it and what they don’t say.  This may become even more important after January when a new Fed Chair, perhaps Bernanke, takes over for retiring Fed Chair Greenspan.

 

Wolfowitz and the World Bank.  It what can only be described as a gusty move the Bush Administration has nominated Paul Wolfowitz to become President of the World Bank.  Wolfowitz comes from the Pentagon where he has, basically, been in charge of the war in Iraq.  Needless to say the Europeans are less than thrilled with the Wolfowitz nomination.

But a closer look at Wolfowitz is in order.  He has PhD in economics (don’t hold that against him) and political science from the University of Chicago.  He has served as U.S. ambassador to Indonesia, the Dean of School of Advance International Studies at Johns Hopkins and a director at Hasbro, the toy maker.  He has a reputation as being a sound manager.  And sound management is something the World Bank desperately needs.

One of the problems with the World Bank is how it is financed.  It borrows money in the global financial market using its AAA bond rating and relends this money to developing nations at 50 to 75 basis points higher.  It uses this spread to pay for it’s over 10,000 employees (Ken Rogoff reports over 300 of these are in the World Bank’s PR department alone) and other parts of its $1.5 billion operating expenses.  So, to keep going the Bank has to keep lending to governments around the world…even if these government really don’t want (or use wisely) the money.  Again as Rogoff is asked:  does it make sense for the World Bank to keep lending (cheap) money to China with its investment grade bond rating?

So maybe the World Bank needs someone tough minded and hard headed like Wolfowitz.  One thing is certain:  it is almost humanly impossible for Wolfowitz to be a bigger disappointment then the last World Bank President to come directly from the Pentagon.  The disaster known as Robert McNamara.

All the best,

MBrandl