The Federal Reserve's knee-jerk reaction to the problems with mortgagees who aren't repaying their loans, and the fear of recession, indicates it thinks these events are worse for the economy than the attack on the World Trade Centre in New York on September 11, 2001. As the Wall Street Journal points out, the 0.75% decline in its federal funds rate to 3.5% is the single biggest cut since August 1982. This is not only ridiculous, but moves the Fed even further away from the job it's supposed to be doing: keeping a lid on inflation.

The Fed statement says it cut rates "in view of a weakening of the economic outlook and increasing downside risks to growth", and adds that "appreciable downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks."

Admirable. If only this was its job. Now, I also used to think that central banks should lower interest rates to boost flagging economies, and I was an ardent critic of the European Central Bank several years ago for doggedly targetting inflation in some EU member states while ignoring the fact that the high interest rates it used as a tool to do this were choking off the economies of other EU member states.

Looking at the Treasurys market, investors had been factoring in a fall in interest rates anyway. But not of this magnitude. Besides, the central bank's job is to keep inflation in check, not to give in to punch-drunk investors whenever the market returns to more reasonable valuations. Does Mr Bernanke give chocolates to his grandchildren each time they ask for it, lest they go hungry before the next meal?

We congratulate Fed governor and Federal Open Markets Committee member William Poole for "voting against" the rate cut because he "did not believe that current conditions justified policy action before the regularly scheduled meeting next week". That's right. The Fed's next scheduled meeting is only than a week away. Like I said: the 0.75% cut is a knee-jerk reaction.

Particularly telling was the comment from Treasury Secretary and Bush appointee Henry Paulson, who is quoted in the same WSJ article as saying "This is very constructive and I think it shows this country and the rest of the world that our central bank is nimble and can move quickly in response to market conditions". With an election in the air, he would say that. One wonders whether Fed Chairman Ben Bernanke and his committee received any phonecalls with "words of encouragement" from the Treasury Secretary.

Perhaps he is hoping a rate cut now will deliver election victory to the Republicans later this year, in the same way a rate hike during last December's election campaign in Australia robbed the Conservative Government of its re-election chances there.


Mark Laudi

Labels: Ben Bernanke, Federal Reserve, interest rate cut, September 11, subprime, William Poole