The markets had expected a bigger cut, they had priced in a full percentage point drop, and yet when Mr Bernanke and chums chose to lower rates by a mere 0.75 per cent, there was much celebration.
In proportional terms, it was the biggest fall in interest rates for a very long time.
On Wall Street, and over here, the Fed seemed to be drawing praise. For a while, they had said Ben was asleep at the wheel, in denial over how bad the crisis was – but not any more.
With prices rising, the fear is that deflation could return, and the Fed is pulling out all the stops to avoid that. In Japan, the decade of lost growth was kicked off after the central bank proved itself reluctant to take the measures needed – when finally it lowered interest rates to zero per cent, it was too late.
The Fed wants to avoid those mistakes.
But not everyone at the Fed was so keen to cut rates. Of the ten men and women who voted, two went against the pack, and voted for a more-modest 0.5 per cent cut. The markets didn’t care, Bernanke is their hero, and his earlier reluctance to lower rates forgiven.
Yet, something strange did happen. The long term rate of interest, that’s the rate set by the markets, rose. Some traders at least, appear to believe the Fed has laid down a recipe for inflation – and that in the longer-term, rates will need to rise much higher as a result.
In fact, yesterday also saw a 0.3 per cent rise in producer prices in February – the inflation genie is either knocking very hard on its bottle, or is actually escaping right now.
Previous deep recessions have been caused by falls in asset prices – such was the case in the 1930s, such was the case in Japan in the 1990s. The trick the Fed has to pull off is to allow asset prices to fall to sustainable levels, without setting off a very nasty recession.
If it boosts the economy too much, then it is merely delaying the day and could create even bigger problems in the future.
If it doesn’t boost the economy enough, then it will be very difficult to avoid a downward spiral.
But never lose sight of the fact that the underlying problem in the US is too much spending and not enough saving – the Fed, by cutting rates so much, is delaying the time when this essential readjustment occurs.
Editors footnote
The Japanese recession was in part made much worse because of a refusal amongst banks and authorities to acknowledge how serious the problem was. They were too slow to make their write-downs and too slow to face reality. Judging by all the doom and gloom, that is one criticism at least you can’t level at Wall Street and the City.
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