Archive for Wednesday, March 19, 2008

Analysis: Fed’s moves may backfire, feed panic

March 19, 2008


— There's a risk in Federal Reserve Chairman Ben Bernanke's bold moves of late.

If recent history is any guide, the euphoria that met the Fed's three-quarter-point reduction to a key interest rate Tuesday could be short-lived. With a string of urgent and aggressive actions, the Fed itself could end up feeding the panicky mind-set that it so desperately wants to calm.

Even inside the Fed there was disagreement about just how much the key interest rate - its most potent tool in dealing with economic trouble - should be lowered.

Two Fed members dissented, preferring a smaller cut, while Bernanke and seven others prevailed with a more powerful three-quarter-point one. Cuts of this size are pretty infrequent. Bernanke, in an emergency session in January, ordered one - making for the single-biggest reduction in more than two decades.

Wall Street was ebullient Tuesday - soaring 420 points - even as it had hoped for greater relief - a rare reduction of 1 percentage point. Yet, one wonders just how long the good feeling will last. Wall Street has been largely engulfed in turmoil since last year, swinging wildly at times between relief and panic.

In a bid to revive a sagging economy, the Fed dropped its the federal funds rate, the interest that banks charge each other, to 2.25 percent. In turn, the prime lending rate for millions of consumers and businesses fell by a corresponding amount, to 5.25 percent. Both are the lowest since late 2004.

The Fed's action was the latest in a series of extraordinary moves - many in just the past few days and weeks - that the Fed has resorted to as it seeks to prevent a financial catastrophe that could plunge the country into a deep and painful recession.

Yet, it raises the question: can the Fed in its very efforts to contain spreading credit and financial crises, end up also spreading fear?

"I think it is true that Federal Reserve actions coming closely one after the other in the last few weeks - while no doubt are helpful for the economy - they carry with them a risk that people will perceive them as involving some slight desperation," said Marvin Goodfriend, economics professor at the Carnegie Mellon University.

The Fed's words - not just its actions - matter a lot and can color how people view the economy and their own financial fortunes. On Tuesday, the Fed was blunt in its assessment that the country's economic health has worsened. "The outlook for economic activity has weakened further," the Fed said. "Financial markets remain under considerable stress and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters."

Such words can make people more nervous. The Fed walks a fine line between trying to give the public an accurate picture of what is going on and at the same time not spooking them - or investors.

"Saying nothing could also trigger a panic as well" and undermine the Fed's credibility, said Victor Li, an economics professor at the Villanova School of Business. "People would be more nervous if the Fed sat back and did nothing."

Still, the Fed's rate-cutting campaign, which started in September, and turned much more forceful in January, hasn't put people into a better frame of mind where they are more willing to spend. Instead, they have hunkered down, adding to the economy's problems. "Maybe the public is saying, the Fed can't really do much about the impending recession," Li said.


igby 9 years, 9 months ago

" Hello, Ben this is George W."

"Hello, Mr. President"

"Ben, I don't care what you have to do, but it's time to put the peddle to the metal".

"I understand perfectly Mr. president"

"consider it done".


jmadison 9 years, 9 months ago

The Fed is following the example of Japan in the 90's. Low interest rates, forced mergers of weak banks or companies with stronger banks or companies. The result was chronic economic malaise in Japan with negative GDP for Japan for years.

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