NEW YORK (CNN/Money) - Dr. Greenspan and Associates face a tough call as they decide how much medicine to administer to the sickly U.S. economy.
A big interest rate cut now could create complications down the road; failing to eradicate deflation before it takes hold and spreads could prove fatal. Thus the dilemma.
Think of all the times the doctor told you to make sure you take ALL the medication prescribed to fight off an infection. If you stop too soon, and let the infection linger, it could take hold and come back to make you even sicker.
But if you opt for a treatment that's too aggressive and you weaken your system, then you may find that the doctor's medicine "cured" you of the disease, but left you vulnerable to a new kind of secondary infection or allergic reaction that's even worse that what you had in the first place.
The Fed's treatment decision is a complicated one. There is no doubt that the U.S. economy is showing signs of stabilizing and even of moving ahead. Jobs are still being cut but the number has slowed to the point where some see small increases in the months ahead. Consumers are still buying houses and cars and Harry Potter books.
And the stock market is in rally mode! Puh-lease, say the optimists -- what better proof does the Fed need that the passage of big tax cuts, the winding down of the war in Iraq, and the amazing mortgage refinancing boon on spending are all taking hold at once and the economy is at long last truly on the mend?
A number of economists, especially those in the Republican supply-side camp, have argued lately that the Fed is in danger of over-doing the rate cuts, that it is setting the economy up for big IN-flation down the road and a terrible rout in the U.S. government bond market.
Recently by Kathleen Hays
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Some say that we could even see another stock market bubble. They look at the falling dollar, the rising stock market and increasing commodity prices as proof that too much money in the system, not too little, is the problem now.
But what if the Fed stops cutting rates now, or opts for the smaller rate cut and then finds out that the cancer of deflationary pressures weren't killed off? What if stocks stop rising for awhile and the fragile gains in consumer confidence start to dissipate? What if the economy keeps shedding jobs? What if tax cuts are saved, not spent? What if there's another terror attack? Etc, etc, etc.
Then, says the camp that wants the Fed to lower interest rates by a half-percentage point, Dr. Greenspan and Associates will have missed a chance to provide the extra dose of medicine that would have given the economy some extra protection against a secondary infection or some lingering germs just waiting for the chance to take hold.
Central bankers, like doctors I suppose, try to minimize the worst mistake they can make. In that vein, the monetary doctors at the Fed will be asking themselves what is the worst mistake they can make tomorrow.
Is it to cut rates more aggressively and end up with too much growth, and the need to raise rates? Or is it to be more careful, to do less, and find out that they didn't do enough and the economy and inflation are sinking toward deflation?
Monetary policy, like medicine, is as much art and instinct as science. We'll know by Wednesday afternoon what the good doctors have decided to prescribe.
Kathleen Hays anchors The FlipSide, airing Monday to Friday on CNNfn. As part of CNN's Business News team, she is also a regular contributor to Lou Dobbs Moneyline.
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