Did the Fed panic?

Like almost everybody else, I was surprised that the Fed cut rates by 75 basis points rather than 50, and I am still wondering why. Even 50, ahead of FOMC schedule, would have been regarded as  strong medicine. And it was a great pity, I think, that the trigger for the move was the equity-market crash, rather than (as far as we know) a sudden surge of worse-than-expected real-economy data.  It is bad practice for the Fed to be perceived as responding with greatest urgency to equity-market fluctuations. Yes, it looks like panic. Read Willem Buiter's take:

This extraordinary action was excessive and smells of fear.  It is the clearest example of monetary policy panic football I have witnessed in more than thirty years as a professional economist.  Because the action is so disproportionate, it is likely to further unsettle markets.  Even the symptoms of malaise that appear to have triggered the Fed's irresponsible rate cut, the collapse of stock markets in Asia and Europe and the clear message from the futures markets that the US stock markets would follow (a 500 point decline of the Dow was indicated), are unlikely to be improved by this measure and may well be adversely affected.

In the absence of any other dramatic news that the sky is falling, I can only infer from the Fed's action that one or both of the following two propositions must be true.

- The Fed cares intrinsically about the stock market; specifically, it will use the instruments at its disposal to limit to the best of its ability any sudden decline in the stock market.

- The Fed believes that the global and (anticipate) domestic decline in stock prices either will have such a strong negative impact on the real economy or provides new information about future economic weakness from other sources, that its triple mandate (maximum employment, stable prices and moderate long-term interest rates) is best served by an out-of-sequence, out-of-hours rate cut of 75 basis points.

The first proposition would mean that the Fed violates its mandate.  The second is bad  economics.

The Fed's brief statement sheds no light:

The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth.  While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households.  Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.

On my reading, there is no attempt to justify the scale of the action; in fact the statement fails even to acknowledge the scale of its action. This narrative could perfectly well have applied to a 25 basis-point cut delayed until the next FOMC. And what the narrative does say ignores the news that presumably caused the Fed to do what it did. Falling share prices are not so much as mentioned, except for the pro forma reference to "broader financial market conditions". So much for Bernanke's commitment to transparency.

Taken at face value, the statement actually makes no sense. If you wanted to defend the manner of this dramatic monetary easing, you would have to say that the stockmarket crash had awakened a hitherto sleeping Fed to the true horror of the problems facing the economy. Is that how Bernanke wants his actions to be perceived? Even if it is, since when does the stockmarket convey that kind of actionable information?  (And if it does convey that kind of actionable information, why only when it falls, not when it rises?)

Not a good day for the Fed, in my view.

Presented by

How to Cook Spaghetti Squash (and Why)

Cooking for yourself is one of the surest ways to eat well. Bestselling author Mark Bittman teaches James Hamblin the recipe that everyone is Googling.

Join the Discussion

After you comment, click Post. If you’re not already logged in you will be asked to log in or register.

blog comments powered by Disqus


How to Cook Spaghetti Squash (and Why)

Cooking for yourself is one of the surest ways to eat well.


Before Tinder, a Tree

Looking for your soulmate? Write a letter to the "Bridegroom's Oak" in Germany.


The Health Benefits of Going Outside

People spend too much time indoors. One solution: ecotherapy.


Where High Tech Meets the 1950s

Why did Green Bank, West Virginia, ban wireless signals? For science.


Yes, Quidditch Is Real

How J.K. Rowling's magical sport spread from Hogwarts to college campuses


Would You Live in a Treehouse?

A treehouse can be an ideal office space, vacation rental, and way of reconnecting with your youth.

More in Business

Just In