Fed Policy
Jude Wanniski
February 4, 1988


Chances of a half-point cut in the Federal Reserve's discount rate to 6% are excellent as a consensus seems to have developed in that direction. Resistance had come from those who feared it would be taken as a sign of aggressive ease, perhaps with partisan overtones. Foremost in this category are Chairman Alan Greenspan and Governor Wayne Angell. But the bond market rally of recent weeks, accompanied by the steady decline in the prices of gold and other metals, has shifted this thinking: The posture of prudent restraint has been vindicated. With gold tumbling more than $60 from its high and the dollar firmly in the mid-range of its G-7 accord, Greenspan and Angell are now in a position to assert that a notch down on the discount rate is not a change in policy at all, but a payoff, a dividend on the policy they have been following. If a discount rate cut comes, backed with this kind of rhetoric, it would be taken constructively by the markets and would boost stocks as well as bonds. It would likely come after the FOMC meeting next week, Feb. 9-10, by a unanimous vote.

Basic Fed policy will be strengthened as a result, not altered. Commodity prices and exchange rates will continue to dominate, which means the Fed will be sensitive to the confluence of dollar/gold, dollar/DM and dollar/yen rates in setting the Fed funds rate. Fed funds has been at 6 3/4% for a considerable period, probably set to officially target non-borrowed reserves. Talk of lowering Fed funds a notch to 6 1/2% is coming from the monetarists, who are pushing for more liquidity. There is no consensus at the Fed for an explicit move in this direction. For such a consensus to develop, gold would probably have to decline to the $425 level coincident with a dollar/yen rate push to the upper end of the G-7 band, about 140. These are very welcome and positive developments. There seems more harmony at the Fed at this juncture than we've seen in the last year, a growing confidence among the governors that they're on the right track.

The open seat at the Fed will not go to former Citibank economist Leif Olsen, by the way. Olsen, a devout monetarist, is ruled out technically because he's from New York, and Greenspan already holds the New York seat. A leading candidate is Wendell Wilkie Gunn, being interviewed at the White House this week. We recently wrote President Reagan and Secretary Baker urging Gunn's appointment. Extraordinarily well-qualified in banking and finance, an alumnus of Chase Manhattan and Pepsico, Gunn was Special Assistant to the President on commerce and trade in the first term. He would be the first black on the board since Governor Rice resigned two years ago and the first black at the Fed ever to favor supply-side growth policies and a commodity price rule.