Monetary muddle revisited.

THE FED cut the discount rate by a full percentage point, even as Germany's Bundesbank was pushing European interest rates in the opposite direction. One immediate effect was to sink the dollar, but that may prove temporary if Europeans, like the Japanese, realize that their real interest rates are unnecessarily high. With inflation way down in all major countries over the past year, a case could be made for simultaneous interest-rate cuts by all the G-7 countries. The case for the U.S. going it alone is more problematic, since there is no question that weakness of the dollar, if it persists, must risk relatively higher U.S. inflation. some argue that a weak dollar is good for trade, bur inflation never made any country more competitive.

The most worrisome thing is the motive behind the Fed's move. The Fed Governors did not slash interest rates because of any signs of a deflationary squeeze, such as a soaring dollar or collapsing commodity prices. Instead, they apparently succumbed to the exaggerated political panic over a few mixed signals of short-term economic weakness. Monetary policy cannot serve two masters: it cannot be used to fine-tune real economic activity and also to stabilize the purchasing power of the dollar. If the Fed cuts interest rates whenever some monthly employment report is disappointing, investors will have good reason to anticipate that the Fed will likewise raise interest rates at the first glimmer of prosperity. Holding Fed policy hostage to the economic news makes it impossible to have sustained economic growth, because bond investors run for cover whenever they see signs of economic growth - fearing the Fed Governors will once again hike interest rates to abort even a non-inflationary expansion.

Monetary policy must instead be concerned with protecting the value of money. To improve the real economy requires minimizing government impediments to employment and investments - including punitive tax rates and costly trade barriers and regulations. The Fed can only print money; it can't print jobs.