In Praise of Flexibility

Everyone wants rules. But sometimes they lead you astray.

In mid-2008 everyone was watching oil and the end of the housing bubble. Oil had recently broken $100 per barrel and many expected that it would soon double in price, adding to inflation. Bear Stearns had just gone bust. Bank managers weren’t sure where their funding would come from each night. Everyone expected further fallout.

In the midst of this, the European Central Bank raised rates. Their inflation indicators—impacted by oil prices—where flashing red. By their rules, they had to raise rates to fight inflation, no matter what the rest of the economy was doing.

The ECB’s rate hike in July of 2008 will likely go down in history as one of the worst Central Bank mistakes ever: tightening in the teeth of a huge financial crisis. After the failures of Fannie and Freddie, AIG, and Lehman, they reversed course and cut rates—following the Fed and the rest of the world.

This is relevant because the Fed is now reexamining its rules for monetary policy. Janet Yellen is a big believer in transparency; rules-based monetary policy might be the next step. But the ECB’s rate-hike in 2008 is cautionary: some rules are made to be broken.

Douglas R. Tengdin, CFA

Chief Investment Officer

By | 2013-11-07T11:36:27+00:00 November 7th, 2013|Global Market Update|0 Comments

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