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Slashing interest rates is just quick fix

Slashing interest rates is just quick fix
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First Published: Fri, Jan 11 2008. 11 51 PM IST
Updated: Fri, Jan 11 2008. 11 51 PM IST
If Thursday’s speech is anything to go by, Fed chairman Ben Bernanke is worried. He seemed to commit himself to cutting the Fed funds target rate again this month, perhaps even by 50 basis points, from its current 4.25%.
True, he’s to some extent at the mercy of exceptionally fragile markets and a bleaker economic picture than in Europe. But his colleagues in London and Frankfurt, faced with milder versions of the same concerns, have chosen to hold for a while and assess the situation, against expectations in some quarters.
On the evidence, Bernanke would do better to do the same thing, even if it rocks markets temporarily. Cutting further is not yet justified by the mix of economic and inflation data, and it’s likely to be relatively ineffective because investors already expect it.
Rather than reassuring everyone that the Fed is still in control of the situation, it would also risk heightening the sense that he has thrown in the inflation-fighting towel and is doing merely what Wall Street wants in its current gloomy mood. Gold prices, up again on Thursday, certainly suggest an inflationary outlook.
Bernanke also clearly wants to respond as economic data emerge in the coming months. Yet, too much cutting too quickly, and the Fed funds rate would start getting alarmingly low. Very low rates worried the Fed under Bernanke’s predecessor, Alan Greenspan, because it left them with no effective leverage over the economy at all.
Bernanke isn’t there yet, but firing off too many pre-emptive rate cuts is no way to conserve a limited stock a stock of dry powder.
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First Published: Fri, Jan 11 2008. 11 51 PM IST