In the wake of the Fed's boost in the discount rate to 7% last week, we asked one of the governors what signals the Fed was using these days to guide policy. "The squeaky wheel gets the grease," was his reply. An honest, informative answer. There's no distinct philosophy that will help us divine what the next move of the Fed will be, except noise. The economy could throw off uniform signals of weakness, but if they seem muffled, another bad number on the Producer Price Index could send Greenspan & Co. into another squeeze. Or a noisier complaint from the White House could trump the PPI. The pretense of solemnly targeting a monetary aggregate or an exchange rate or a commodity price is gone. The political chemistry of the Beltway is all important.
The White House is properly concerned, worried that some of the recent oil price hikes will put another bulge in the February price indices. The Fed governors obviously think the economy is strong enough to withstand this new boost in short rates, or that they will be able to act quickly enough to reverse field if signs of softness show up on the economic scope. The Bush team is correct in worrying that the Fed will damage the economy by overshooting, and as usual will then overcompensate for its deflationary error by easing too much.
It has been Wayne Angell's rule of thumb at the Fed that policy always errs by one notch too many in both directions. He was alone in August 1986 when gold was at $350 and his colleagues voted to ease one notch too many. He's been supportive of the tightening moves, including last week's, still trying to squeeze the toothpaste back into the $350 tube. At 9 3/4% fed funds, he'll surely get there in a month or two, and we'd be happy enough if that would be that. But even this may be one notch too many to give us the real growth we've been counting on for 1989.
There is still no sign of a dollar policy in the Bush Administration, which we have been recommending since November. If long-term interest rates are going to fall according to plan, the markets have to have a better guarantee of dollar integrity than a squeaky wheel. If the White House and Treasury fret that the Fed has too much power to screw up, all they have to do is take power away from it by formulating a dollar policy and asking the Fed to accommodate it. This is what we advised Jim Baker and Donald Regan in 1981, when they had the same worry about the Volcker Fed. The policy ipso facto would suddenly be the squeakiest of wheels, overriding PPI and CPI blips.
Alan Greenspan and Nick Brady at least in part seem to be reacting to the squeaky wheel at the Bundesbank. The Germans continue to harp about the U.S. budget deficit, matching every Fed squeeze with one of its own. This keeps the dollar within the G-7 range, preventing that wheel from signaling an easing of policy. This is why the Bundesbank hesitation in matching this latest Fed boost with one of its own is good news. If the dollar pushes up against the G-7 ceiling as the gold price continues to slide, the White House would have something to shout about in its skirmishes with Greenspan.
We're not as bullish as we were a month ago, when our soundings suggested this latest tightening could be avoided. The PPI and CPI bombshells required stronger nerves at the Fed than were available. Our best guess is that March will produce smaller tremors and the April numbers will bring the turnaround we've been awaiting.