So Far, So Good At The Fed

Let's hope that as the economy heads toward recovery, the Federal Reserve draws the correct conclusions from the past two years to guide its policy. The most obvious is that monetary policy works. The most important is that bold policy action will achieve what timid moves cannot.

Last year's series of small quarter-point cuts in the federal funds rate failed to produce a sustainable recovery. Those cuts were widely anticipated in the financial markets by the time they were enacted, so they didn't generate the kind of psychological impact required to lift the economy out of its funk. On the other hand, signs now point to faster growth after the Fed's large half-point cut on Dec. 20 and its bold move on Feb. 18 to cut reserve requirements - moves that took the markets and the public by surprise.

The Fed's task now is to avoid its mistakes of last year. For the present, with the economic data looking much better, that means doing nothing. Further easing would be counterproductive because it would spook the inflation-wary credit markets. However, any thoughts of tightening should be put off for a long time. Under the heavy weight of debt and other structural problems, the recovery cannot tolerate the slightest hindrance.

Forget about stubbornly high long-term interest rates for now. The Fed's past tightness, which produced three years of feeble economic growth at an annual rate of 0.5%, has tamed inflation. When the price indexes finally convince the bond market that inflation is dormant, long rates won't be so jumpy in the face of recovery. But if policy action by the Fed in either direction is required along the way, the lesson from 1991 is that it should be quick and bold.

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