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Bernanke to Cut Rates Further, Faster as Inflation Concerns Ebb
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01/23/2008 12:53 AM
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Bernanke to Cut Rates Further, Faster as Inflation Concerns Ebb
[link to www.bloomberg.com]
By Craig Torres
Jan. 23 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke has decided inflation concerns have faded enough to let him cut interest rates further and faster to keep the U.S. from tipping world economies into recession.
``Now they are free to move very aggressively,'' said New York University professor Mark Gertler, a research co-author with Bernanke and policy consultant at the New York Fed. ``They want to avoid asset panic. They don't want the declines to disrupt credit flows.''
The Fed's emergency rate cut yesterday signals a dramatic shift by policy makers from inflation to growth concerns. It indicates they now see a risk of lower home and stock values feeding back into tighter credit conditions that threaten to choke off growth, economists said.
A decline in oil prices, lower readings on expected inflation, higher unemployment and slowing factory production all helped convince the consensus-driven Federal Open Market Committee that they could both maximize rate cutting and accelerate the pace.
Futures trading suggests the Fed might follow up with a cut of as much as another half-point Jan. 30, bringing the decrease to 1.25 percentage points in just eight days. Such a reduction, forecast by analysts including Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc., and Dean Maki, managing director at Barclays Capital Inc., would be the deepest since the Fed started using the federal funds rate as its main monetary policy tool around 1990.
``Fighting inflation can follow a plan; combating weakness requires improvisation,'' said Vincent Reinhart, former director of the Fed's Division of Monetary Affairs. ``Now, they've switched gears'' and ``will keep easing'' until they sense the economy has reached a turning point.
For Bernanke, 54, that's an about-face from the past five months, when inflation formed the ballast of every policy decision, and forecasts, not markets or near-term data, drove changes in interest rates.
Until yesterday, the Fed had lowered the benchmark lending rate just 1 percentage point in the face of economic weakness, and had used separate tools to deal with liquidity problems in credit markets.
The inflation-wary pattern of rate moves under Bernanke befuddled investors who criticized the central bank for treating the symptoms of tighter credit without diagnosing the eventual impact it would have on the economy.
`Tame, Timid, Tardy'
``This should have been done months ago,'' said Steven Einhorn, vice chairman of New York-based Omega Advisors Inc., a $5 billion hedge fund, in response to yesterday's rate action. ``I have a lot of respect for capital markets, and they have been unambiguous in their view of the Federal Reserve: Up until now, every debt instrument out there told you they had been tame, timid and tardy.''
Gertler, who co-wrote a series of papers with Bernanke on how asset prices influence lending, said the Fed had good reason to rely on tools other than monetary policy to address turmoil in credit markets during the last five months of 2007, a strategy he termed ``masterful.''
In August, Fed officials reduced the cost of direct loans from the central bank, and continued to fine-tune ways banks could use the so-called discount window to boost the flow of credit to financial markets. In December, the Fed introduced the term-auction facility, aimed at distributing cash throughout the banking system, to remedy the increasing wariness of financial institutions to lend to each other.
As policy makers acted three times between September and December to lower the federal funds rate, none of their statements suggested they had begun a sustained campaign of rate cuts.
``They seemed to not fully understand the implications of the seizing up of credit,'' said Einhorn, former head of global research at Goldman Sachs. ``They weren't pre-emptive, and the capital markets gave them ample evidence they were behind the curve.''
Gertler said the Fed could ill afford to move too quickly to cut rates last year, with the economy growing 4.9 percent in the third quarter, oil marching toward a record $100 a barrel and unemployment below 5 percent until December.
If Fed officials had cut rates in August, ``markets would have been screaming, `Helicopter Ben!''' Gertler said, a reference to Bernanke's 2002 quip about fighting deflation with a ``helicopter drop'' of money.
Gertler said ``the whole key'' to creating conditions for aggressive easing ``is anchoring inflation expectations,'' even if that must come at a cost of slower growth. ``If the Fed had dropped rates like a rock at the first hint of bad news, they seriously risked the danger of losing credibility,'' he added.
While the Fed has two mandates from Congress, low inflation and sustained growth, current Fed officials have made stable prices the essential condition on which their ability to offset growth risks is based.
They tolerate monthly movements in the consumer price index. What those measures mean to the public's view of future prices, a concept economists call ``expectations,'' is what really counts.
``They have been closet inflation targeters,'' said Reinhart, now a resident scholar at the American Enterprise Institute in Washington. ``Hence, they were grudging in delivering policy ease last year and had trouble explaining their action.''
To contact the reporters on this story: Craig Torres in Washington at email@example.com
Last Updated: January 23, 2008 00:14 EST
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