Whether or not rogue trader Jérôme Kerviel helped panic the Federal Reserve into last week’s emergency interest rate cut is a fun debate. It is also largely irrelevant.
The Fed was determined to loosen monetary policy aggressively for real economic reasons. Bringing forward its three quarter point cut by a week helped stop the chance of a stock market meltdown or, for critics, was a sign the central bank panicked for the wrong reasons. Either way, those few extra days with rates at 3.5 per cent will make no real economic difference.
More important is whether the Fed follows through with a further half point cut on Wednesday. After all, there is no way the central bank would have cut rates from 4.25 to 3 per cent in a single meeting. If the Fed does cut again, the market swoon really will have affected the magnitude of monetary policy loosening.
A lively debate is likely. There was already dissent at the Fed over last week’s emergency cut. One factor is the fear of fuelling investors’ belief that the Fed will always ride the rescue. That is clearly not healthy. The central bank needs to end the perception. The trouble is, with the economy showing real signs of weakness, the Fed might have to wait until the next tightening cycle to achieve that – when it must be prepared to raise rates as aggressively as it is now cutting.
For now, the Fed’s latest reference to “a deepening of the housing contraction as well as some softening in labour markets” makes more cuts likely to try to reduce the probability of worst-case economic scenarios. Even with a likely $150bn US stimulus package, there is justifiable fear of a nasty downward spiral developing as the battered financial system reduces the flow of credit to the real economy.
Having made its bed the Fed must lie in it. Investors, with their unhealthy faith in the central bank’s ability to solve problems, are betting on further largesse. Having reacted so aggressively to the market swoon, it would be bizarre only days later for the Fed itself to risk triggering a sell-off by failing to deliver.