Anti-Bagehotists in DC

27 January 2010 By Martin Hutchinson

The U.S. central bank is withdrawing liquidity while keeping interest rates low the opposite of Bagehot’s crisis advice to lend freely but at high rates. The Fed’s tactics beat keeping the firehoses running, but could restrict credit to important sectors like small business.

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The Federal Open Market Committee at its meeting Jan. 27 kept the Federal funds target interest rate at zero to 0.25 percent and reaffirmed its decision to end most of its special liquidity facilities on Feb. 1. Its facilities for purchasing $1.25 trillion of agency mortgagebacked securities and $175 billion of agency debt will end on March 31 and will be wound down before then.

The FOMC noted that economic activity has continued to pick up and the deterioration in the labor market is abating. However it also reaffirmed its belief that economic conditions "are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

M2 money supply rose at an annual rate of 1.2 percent in the six months to Jan. 11, but fell at a 1.2 percent annual rate in the two months to Jan. 11. The adjusted monetary base rose at an annual rate of 40.4 percent in the six months to Jan. 11 but fell at a 10.6 percent annual rate over the two months prior to that date.

The Senate vote on Federal Reserve Chairman Ben Bernanke's renomination for a second fouryear term beginning on Feb. 1 is expected to be held on Jan. 28.

Walter Bagehot, a 19thcentury British journalist, is famous for the following prescription for financial crises: "Very large loans at very high rates are the best remedy for the worst malady of the money market."

FOMC statement.

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