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Bernanke Sets The Right Tone

Ben has a really hard job right now. He's caught between his mandate for controlling inflation (which may require an interest rate increase) and full employment (which may require a cut in rates).
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I've been very critical of Bernanke over the last few weeks, largely because I viewed his cut in the discount rate as the first move in a cut in the Fed Funds rate. My concern here was the Fed engaging in a policy which would encourage more reckless lending behavior. This is the exact same policy that got us into the current mess in the first place.

It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In a statement issued simultaneously with the discount window announcement, the FOMC indicated that the deterioration in financial market conditions and the tightening of credit since its August 7 meeting had appreciably increased the downside risks to growth. In particular, the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.

The incoming data indicate that the economy continued to expand at a moderate pace into the summer, despite the sharp correction in the housing sector. However, in light of recent financial developments, economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation. Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country. Inevitably, the uncertainty surrounding the outlook will be greater than normal, presenting a challenge to policymakers to manage the risks to their growth and price stability objectives. The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets.

The emboldened sentences are key. Here's the translation.

1.) If you made a bunch of bad loans it's your fault, not ours. Don't expect a bail-out just because you're stupid.

2.) However, there are broader implications to what is happening in the credit markets. If the economy starts to really slow down because of what is happening, we'll have to do something.

He goes on to make some very important points as well.

3.) Recently released economic numbers should be discounted if their constituent parts occurred before the current mess started.

4.) Going forward, we will be especially sensitive to any sign that overall economic growth is slowing because of the problems in the credit markets.

Let's face facts -- Ben has a really hard job right now. He's caught between his mandate for controlling inflation (which may require an interest rate increase) and full employment (which may require a cut in rates). No matter what he does he'll be relentlessly criticized.

But this statement is the perfect compromise because he's essentially saying the following.

1.) We won't bail-out people who were stupid.

2.) We will act to help alleviate the effect of stupid business decisions if those effects start to really hamper growth, and

3.) The economic numbers over the next few months are very important.

While I am still concerned that lower rates will lead to a de-facto bail-out, the underlying reason for lower rates won't be a bail-out but instead to help the broader economy if needed. I can live with that -- and I bet the markets can, too.