Financial Times Editorial Comment: Bernanke’s dilemma

Financial Times Editorial Comment: Bernanke’s dilemma
Copyright The Financial Times Limited 2007
Published: August 26 2007 19:02 | Last updated: August 26 2007 19:02


So far, so skilful. The Federal Reserve restored some stability to dislocated credit markets without a cut to its key interest rate. Instead, it reduced the cost for banks to borrow from the Fed’s “discount window” and injected liquidity into the system.

The real test comes next. Will the central bank cut the Fed funds rate? Some still believe the Fed might be forced to act before its next scheduled meeting on September 18. The futures market is pricing in cuts by the end of the year. Two-year Treasuries are yielding a full percentage point less than the Fed funds rate. And equities seem to be banking on cuts. The S&P 500 has rebounded and is only 5 per cent off its highs.

That leaves the Fed in a tough spot. It does not want to be seen to bail out financial markets. But it realises that significant changes to the cost and availability of credit will make an impact on the real economy if they persist. The Fed acknowledged that on August 17 when it said “downside risks to growth have increased appreciably” and made no reference to inflation risks – a clear change from its previous inflation-focused outlook.

Also, it is not simply a question of the Fed declining to bail out financial speculators who took on excessive risk. Consumers also made rash bets. Some bought overpriced houses with excessive leverage. Prices nationally, on some measures, are now falling. That could cause serious pain – exacerbated by tighter mortgage credit – and weigh on the broader economy. Ben Bernanke’s speech on “housing, housing finance and monetary policy” this week could be important given property’s pivotal role for both credit markets and the economy.

Assuming no more market spasms, the Fed should wait until its next meeting and absorb the beige book survey, employment report and other data before deciding its next move.

The trouble is, encouraged by the Fed’s new outlook statement, investors may have run ahead of themselves in assuming a rapid burst of monetary easing. That helped stabilise markets in the short term. It also made Mr Bernanke’s balancing act tougher. Now, failure to deliver the expected cuts could even trigger another wave of turmoil by itself.