The Elephant in the Room

I was going to devote my blogging time tonight to something completely innocuous, like vegans. Unfortunately, the elephant in the room is the Fed's decision to cut interest rates by three quarters of a percentage point to 3.5%--a decision that has greatly impacted the media and blogosphere. Bernake's surprising move--not only by cutting the rate by such a significant amount, but by doing it a week before the Fed meeting--demonstrates not only the disastrous state of our economy, but has engendered a debate among analysts and financial journalists as to whether the Fed's actions were a response to growing concerns over a recession or jitters over global stocks plummeting on Monday.

The Economist suspects that something fishy is going on:

The deepening gloom about the economy may well warrant such an aggressive response. But the timing is puzzling. There is more than a whiff of panic about slashing rates little more than week before a scheduled meeting. The Fed statement issued with the decision rationalises the cut as a response to “downside risks to growth”—the phrase is repeated twice in six short paragraphs—and cites recent gloomy data on housing and jobs. Yet the economic news has not grown any worse in the past few days and, given the time needed before monetary policy affects spending, the added urgency seems odd.

[...]

In his short tenure the Fed’s chairman, Ben Bernanke, has only used scheduled meetings to make changes to the Fed’s main policy rate. That he was moved to act just a week before one will raise the suspicion that the Fed knows something that markets don’t.

Felix Salmon also has his doubts:

There's nothing in there to justify a huge rate cut in the week before a regularly-scheduled meeting. Tighter credit for some households? Come on. There's one reason and one reason only that the Fed took this move, and it's the plunge in global stock markets on Monday, along with indications that the US markets were set to follow suit.

Now the Fed is charged with keeping employment high and inflation low; it's not charged with protecting the capital of investors in the stock market. So this action smells a bit like panic to me, and it might also have prevented the kind of stomach-lurching selling which could conceivably have marked a market bottom. I have to say I don't like it.

And here's Mark Thoma:

I can't say I expected this to happen today. So far so good, stock markets are recovering, at least for the moment [just back from class, see here on stock values], but the 75 basis point cut is aggressive and makes me wonder if there are things the Fed knows that we don't. In that sense, I hope this move calms markets rather than reinforcing their worries.

There seems to be a lot of this "I wonder what Bernake is up to" or "Does the Fed have some insider information and consequently a cunning plan" talk. That could be. A week is a relatively long time in the financial world and it is plausible that the Fed is making a wise choice by being aggressive.

I can't claim to know enough about the situation or about Bernake's resume to make a reasonable speculation as to his motives and intentions. However, it seems to me like panic rather than prudence.