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FYI ...   Monday - Sep  1,  2008

2:45 PM ET:  This afternoon, Federal Reserve Bank of Kansas City President Thomas Hoenig spoke on the changing mandates of the Federal Reserve during the recent financial crisis. Hoenig emphasized his concern that the Fed not encourage moral hazard and that the Fed needs to continue to look at the issue of prepared procedures for orderly liquidation of financial firms that come under distress. He argues against a "too big to fail" default policy. He believes that too big public safety nets have adverse effects. Hoenig believes that any institution that seeks discount window assistance should come under Federal Reserve regulation. He also noted that core PCE inflation is above Fed preferences and that policies helping the financial markets are making fighting inflation more difficult. The key point is that a regional Fed president sees current monetary policy as fueling inflation-suggesting that regional Fed presidents increasingly are going to push for rate increases soon.

"In the face of accelerating inflation, it is important that we not calibrate policy principally to deal with the financial crisis if it involves compromising to an unreasonable extent our ability to achieve our mandate for price stability. In the United States, core PCE inflation has been above most definitions of price stability for the past four years and is poised to move even higher over the near term. The current stance of policy, while understandably calibrated for responding to the immediate financial crisis, will make it difficult to achieve our mandate for price stability over the long run." -- R. Mark Rogers

9:30 AM ET: Federal Reserve Governor Randall S. Kroszner spoke this morning at an economics conference in Buenos Aires, Argentina. He addressed somewhat academic issues related to whether the U.S. remains heavily integrated in the international economy. He did not directly address monetary policy and only indirectly touched on the current status of the economy.

The bottom line is that Governor Kroszner sees the U.S. and world economies heavily integrated. Events overseas will continue to impact U.S. financial markets and economic growth - and the reverse holds true. Two issues of integration stand out. Slowing economic growth in the U.S. adversely affects growth overseas and, in turn, leads to a further slowing in the U.S. through exports. Also, rising food and energy costs affected not just the U.S. economy but economies world-wide.

Kroszner specifically notes how the U.S. subprime problems unexpectedly affected other economies.

"Some commentators suggested last year that the rest of the world would remain relatively unaffected by the housing slowdown in the United States. However, as turmoil emerged in financial systems around the world in the late summer of 2007, it became clear that this was not the case. Concerns about financial securities backed by U.S. mortgages spread to asset-backed securities more generally, which led to funding difficulties in European money markets at anything but the shortest maturities."

Indeed, the Fed governor emphasizes the linkages between economies for growth and inflation.

"Moving into 2008, concerns about potential spillovers from slower U.S. growth and weaknesses in the financial system weighed increasingly on advanced economy equity markets. As the step-down in growth of gross domestic product (GDP) in a number of advanced economies became apparent, we also began to see reduced growth and prospects for growth in many emerging market economies, and stock markets in emerging economies declined sharply. Throughout the world, the challenges posed by weakening economic activity were further complicated by mounting inflationary pressures as food and energy prices soared. By now I believe it has become clear that the initial assessment that the United States had decoupled from the rest of the world was incorrect, and that, in fact, the global economy remains closely connected by both trade and financial linkages."

Kroszer makes the case that reducing trade barriers is important for keeping inflation down.

"When domestic markets for goods and services are unrestricted and open to sellers worldwide and when supply adjusts efficiently to meet changes in demand, costs to consumers are minimized. The recent sharp increases in global food prices have underscored the importance of reducing barriers to trade in agricultural products. Reducing such barriers was one of the key subjects of the latest set of talks in the Doha round, and I am disheartened that this round of talks collapsed. Given the urgent need to expand the global food supply to meet burgeoning world demand, it is particularly unfortunate that these negotiations were unable to make progress."

The bottom line from a practical perspective is that one needs to monitor growth and inflation abroad to fully understand trends in the U.S. Currently, growth is slowing abroad while inflation remains high, suggesting that the Fed still has its work cut out in terms of bringing inflation down. -- R. Mark Rogers