January 22, 2001

The recent stock market turbulence has raised the specter of the "R" word. Read the financial pages in the paper and you'll notice that an increasing number of people are now talking about the likelihood of a recession. If, as we believe, Greenspan is following the price rule and the spirit of Knut Wicksell is alive and well in the hallways of the Federal Reserve, a number of implications are easily derived: First, the U.S. inflation rate will remain under control. Second, fluctuations in interest rates will mirror fluctuations in the real rate of return (i.e., the Wicksell hypothesis). Third, since the Fed is following a price rule, the fed funds rate will chase the real rate of return. Fourth, if the real rate of return is positively related to the level of economic activity, then the fed funds rates may be a good predictor of economic activity.

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