Should the Fed Cut Again?

As much as Wall Street might need a grandmother from time to time, it isn’t the central bank’s job to dry the stock and bond markets’ tears whenever there’s a thunderstorm--let alone try to save the world.

The Fed has a tough enough job doing what it was created to do--maintain domestic price stability and an orderly financial system--without trying to take on new responsibilities, the opponents of further interest rate cuts argue.

The strict constructionists say it isn’t even legal for the Fed to concern itself with the turmoil in overseas financial markets that spread from Asia to Russia to Latin America in summer. But legalities aside, the Fed risks muddying its mission and destroying its hard-won reputation if it tries to do too much.

“The Fed can’t solve Brazil’s problems; it can’t solve Japan’s problems; it can’t solve Russia’s problems,” said Charles I. Plosser, dean of the William Simon Graduate School of Business at the University of Rochester in New York.

As for dealing with market fears, “the only logical role for the Fed is to let the markets understand that it is not going to let panic set in, that it is standing ready as a lender of last resort,” Plosser said.

And with its two back-to-back rate cuts since Sept. 29--reducing its key short-term interest rate, the federal funds rate, from 5.5% to 5%--the Fed has already sent that signal, Plosser said, just as it responded rapidly to the stock market crash of 1987.

Enough is enough, he said.

Plosser is a member of the “Shadow Open Market Committee,” a panel of Fed-watching private economists.

Anna J. Schwartz, an economist with the National Bureau of Economic Research and a colleague of Plosser’s on the Shadow committee, takes an even harder line on the Fed’s straying from its congressionally mandated role.

“They’re not psychologists and they delude themselves if they think they can solve the world’s problems,” Schwartz said. Like a good shoemaker, she added, the Fed “should stick to its last.”

Departure from tradition isn’t a bad idea only from a philosophical standpoint; it also can cause lasting damage to markets, Plosser said.

“If they start going off on a different path, their credibility is in question,” he said. “The markets would ask, and rightly so, ‘When are they going to shift [policy priorities] again?’ ”

The more discretionary the Fed becomes in selecting factors in its rate decisions, the weaker its message to markets becomes.

Added Plosser: “Instability is created by wondering what the Fed is going to do.”

Fundamentally, rate cut opponents say, the case for a slowing U.S. economy (which would justify more rate cuts) is hard to make in the face of data showing that jobs continue to be created, the auto and housing markets are strong, and the money supply is practically exploding.

Two of the Fed’s biggest inflation hawks--William Poole and Jerry Jordan, presidents of the Federal Reserve Banks of St. Louis and Cleveland, respectively--made that point at a policy meeting several months ago, Schwartz noted.

Recessions “don’t come in out of the ether,” said Ian Shepherdson, chief U.S. economist for High Frequency Economics in Valhalla, N.Y. The factors that normally drag an economy down--principally rising inflation and rising interest rates--simply aren’t present today, he said.

The continued strength in U.S. consumer spending is no illusion, Shepherdson argues. Consumers may say they’re worried, but watch what they’re doing, he said: buying cars and houses at a furious clip. That doesn’t sound like a recipe for the recession--or worse, the depression--that some fear-mongering analysts say is on the horizon.

Finally, Shepherdson and Schwartz both note that the rising money supply indicates that U.S. banks are continuing to supply credit to businesses--suggesting that at least domestically, the talk of a credit crunch is overdone.

All told, these economists argue, there is no legitimate reason for the Fed to cut interest rates further right now.

Times staff writer Thomas S. Mulligan can be reached by e-mail at thomas.mulligan@latimes.com.