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Monetary Policy: The Punch Bowl

by Elaine Schwartz    •    Jun 28, 2013    •    637 Views

Sort of like Max in Maurice Sendak’s, Where the Wild Things Are, the Federal Reserve sometimes says, “And now, let the wild rumpus start.” Then though, Max cries out, “Now stop!” and sends “the wild things to bed without their supper.”

Max reminds me of the Fed chair who said his role was to take away the punch bowl just as the party was beginning. Attended by most of us, the party can become “wild.” Typically, it starts with low interest rates that let us borrow and buy houses that had been unaffordable. It continues with businesses adding to inventory, buildings and jobs through inexpensive loans. Next, government joins the fun by funding new schools and employee benefits. Then though, just when everyone is having the best time, the Fed is supposed to remove the punch bowl by raising rates.

It is tough for the Fed to remove the punch bowl before individuals, businesses and municipalities borrow more than they can afford. After all, implementing monetary policy, the Fed can’t be sure of the proper moment to act nor how much financial unhappiness rising rates will create. But they do know that they will constrain rising markets, declining unemployment and increasing construction.

The film that I just saw at the Nantucket Film Festival perfectly conveys the huge dilemmas faced by Fed chairmen. Telling the story of all the Federal Reserve leaders who let the party continue and the few who did not, “Money for Nothing” is a superbly interesting story of the Fed that combines history with our current plight.

Arriving home after the movie, I saw news articles that corroborated all the film said. Fed officials are trying to calm investors who are distressed by historic pops in mortgage rates while politicians in Illinois are concerned with escalating borrowing costs that will make rebuilding the Red Line, a commuter railroad, more expensive. (Appropriately, the title of one of the articles was, “Cost of Public Projects Is Rising, and Pain Will Be Felt for Years.)

Our bottom line: The debate over the punch bowl never ends. How and when should the Fed wean us from the historically low interest rates we are currently enjoying?

Here is the “Money for Nothing” trailer:

Sources and resources: You might enjoy seeing the text of Maurice Sendak’s masterpiece, Where the Wild Things Are and pondering a Fed connection that I am sure he never contemplated. Meanwhile, with specific detail, the NY Times described the impact of rising rates on municipalities and this LA Times article looked at housing. Finally, do try this Fed game and see how you fare when you try to manipulate interest rates.

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