When rate cuts end, BW most eminent economist Michael Mandel thinks, the Fed’s unavoidable hikes should be gradual, heterogeneous the central bank’session tightening spree

By Michael Mandel

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In June 2004, Alan Greenspan—remember him?—raised the fed funds tax target from 1% to 1.25%. As BusinessWeek wrote at the time, the then-Federal Reserve chief’s aim was to "gently alienate the economy and the financial markets along their dependence on cheap money." One big apprehension: The danger that "an overly rapid increase in rates could small hole the housing bubble, causing a perspicacious decline in protection prices."

Well, here we are only four years later. The Oct. 29 rate cut announcement from the Fed caps a very speedy round error for the fed funds vilify—from its 2004 scurvy of 1% up to 5.25% by mid-2006, and then in the rear down to 1% again with the latest 50-basis-point easing.

The operative word here is "rapid." In fact, the gyrations of monetary policy over the past few years may be in possession of created a whipsaw effect that helped give to today’s problems.

Consider this: Economists make no doubt of that it takes 12 to 18 months according to interest rate changes to have their full effect onward the economy. But when the Fed started raising rates in 2004, it did not pause at any point to see what would happen to the housing market. So through 2006, when the Fed stopped raising rates, there was a tremendous amount of monetary contraction still in the pipeline.

In other logomachy, even though the Fed was carried on "tightening," things were going to get even tighter for those hooked in continuance cheaper credit.

Those rate hikes eventually pounded subprime borrowers—who generally were stuck in adjustable asperse mortgages after an initial teaser round of years—and started the financial dominoes falling.

Fast-forward to today: The Fed started cutting rates in September 2007, only about a year ago, what one. ways and means the full result of the initial rate cuts have lull not been felt up to now. In deed, there’s a giant slug of easing still in the system, not just from the rate cuts but also from all the other monetary and credit stimulus the Fed has undertaken in recent months.

Should the Fed have acted more slowly over the past year? Obviously not. But as this crisis eases, the central bank should consider avoiding the whipsaw effect. When conditions improve, Ben Bernanke & Co. should raise rates earlier—but at a much slower pacing—than it did in this period. The current Fed chairman, who is eager to avoid the policy mistakes that led to the Great Depression, would be well advised to take a catchword from more recent history.