Is the Fed being a ‘fool in the shower’?

February 1, 2008
shower

Unless you have been living in a cave, you’ve already heard about the Federal Reserve‘s cut in its funds rate over the past two weeks. The rate has gone down a whopping 225 basis points in the last four months. But the Fed Chairman Ben Bernanke has not only been cutting the funds rate, but he has also been infusing the market with tonnes of cash lately.

Considering that it takes a while for any funds rate cut to ripple through the economy, mortgage planner Dan Green is wondering if the Fed is acting like the proverbial fool in the shower.

Economist Milton Friedman referred to this scenario as the “fool in the shower”. And it goes a little something like this.

When the fools turns on the shower, the water is very cold. So, he turns on the hot water. Only the hot water doesn’t come on right away so he turns it on full blast. Before long, the water gets very hot, very fast and scalds him. Reflexively, he dials back the heat only to find that he’s too cold again.

Are more rate cuts coming our way in the subsequent meetings? Having read about Bernanke‘s history, it looks like there will be more. But the question, when and how fast will he take the rates up again?

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