Fed chief’s rate strategy draws praise, criticism
washington -- In the current credit crisis, Federal Reserve Chairman Ben S. Bernanke has carved a careful path, ensuring there is sufficient money to encourage lending but not enough to stoke an inflationary boom.
Bernanke has managed this balancing act by temporarily opening the central bank’s credit spigots at a time when nervous investors have been closing theirs.
The Fed added $2 billion in credit to the economy Monday atop the $62 billion it added last Thursday and Friday.
But the chairman is trying hard to avoid the other step available to the central bank: cutting key interest rates. Making that move would help prop up the housing market by driving down mortgage interest rates and would make it easier for hedge fund managers and other Wall Street traders to sell their risky securities. But it also would forestall what many feel is a painful but necessary adjustment.
Bernanke has come in for plenty of criticism for his careful approach. CNBC television commentator Jim Cramer went on an on-air tirade last week, angrily accusing the Fed chairman of being “asleep” and saying Bernanke “has no idea how bad it is out there.”
But calmer voices are praising Bernanke’s handling of the crisis. “With so much money sloshing around out there, it may not be the wisest move to make it cheaper” by cutting rates, said Alice M. Rivlin, former vice chairwoman of the Fed.
Events ultimately may frustrate Bernanke’s strategy and force the Fed to cut rates. If the stock and bond markets take a sudden nose dive, or investors begin demanding their money back from funds, or banks stop lending to one another or to their customers, the central bank could be forced to cut rates dramatically to avoid a freeze-up in the nation’s -- and the world’s -- payments system.
But at least on Monday, it appeared that the immediate crisis had passed, as both the Fed’s actions and those of the European Central Bank, the Bank of Japan and the Reserve Bank of Australia had pumped close to $400 billion into the global economy.
“Money-market conditions are normalizing and . . . the supply of aggregate liquidity is ample,” the European bank said in a statement.
Central banks manage the economy by setting a target for the interest rates commercial banks charge for short-term loans to each other. When the actual rates that commercial banks are charging rise above that target, it’s seen as a signal that credit is drying up.
Central banks react with so-called open market operations, in which they buy up notes and bonds and pump money into the economy through their payments.
Fears that banks are holding troubled U.S. sub-prime mortgages have caused them to be reluctant to lend to each other out of concern that they will not be repaid.
In seeking to handle the current problem with the credit spigot rather than the rate cut, Bernanke is attempting to hew to a different course than his predecessor, Alan Greenspan. When Greenspan faced crises that froze the payments system, he regularly resorted to rate reductions.
Following the 1987 stock crash, for example, the Greenspan-led Fed cut rates about half a point. In the wake of the collapse in 1998 of Long-Term Capital Management, a large hedge fund, the central bank sliced rates by three-quarters of a point in less than six weeks. And after the Sept. 11 terrorist attacks, the Fed began a run of rate cuts that ultimately sliced 2¼ points from the federal funds rate, the rate that banks charge each other for short-term loans.
Of course, each of those events was far more cataclysmic than the current trouble. “I don’t think this one qualifies as a major freeze-up yet,” said Edward M. Gramlich, a former Fed governor. Faced with events of similar magnitude, Bernanke might well opt for rate cuts.
But before becoming Fed chairman, Bernanke had a long career as an academic economist, contending that market panics should be handled with temporary injections of credit rather than with rate cuts. He argued, for example, that the central bank could have helped prevent the damaging bank runs of the Great Depression by pumping money into the system so that banks could pay off depositors and thereby allay people’s fears that they would be unable to get their money out.
Much of the criticism of Bernanke’s performance in the last week stems from the Fed’s decision to issue a statement last Tuesday, two days before the crisis erupted, that the central bank’s primary concern was not credit, but inflation.
The statement, which followed a meeting of the Fed’s policymaking Federal Open Market Committee, noted recent problems with credit. “Financial markets have been volatile in recent weeks,” the statement said, and “credit conditions have become tighter for some households and businesses.”
But the statement went on to say that “although the downside risks to growth have increased somewhat, the committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected” -- and therefore the panel was maintaining the federal funds rate at 5.25%, where it has been for more than a year.
The statement made the Fed appear out of touch with market conditions and unaware of the danger of the payments freeze-up, said Denver economist and veteran Fed watcher David M. Jones.
