The Fed: Say Anything

Forbes ^ | 8/30/2007 | Liz Moyer

[bruinbirdman]

The last time Federal Reserve Chairman Ben Bernanke spoke at the annual bankers conference in Jackson Hole, Wyo., everyone hoped he'd keep his mouth shut about interest rates. This time, it's the only thing people want to hear him talk about.

Bernanke speaks tomorrow at the annual gathering in what is arguably his most important speech since taking over for Alan Greenspan in February 2006. It will be the Fed chairman's first public comments since the credit and debt markets started to go haywire in late July.

What's he going to say? The Fed never comments on the topic ahead of time. But he's not likely to come out and say what will happen at next month's open market committee meeting, when a rate cut could come. He is likely to repeat his view that there is a distinction between falling securities prices and a market breakdown.

That's the delicate balancing act the Fed is navigating. While Wall Street wants a rate cut, the Fed wants to make certain that whatever it does do, it is clear that it's not doing it just because Wall Street wants it to happen.

"They have to weigh the cost of a bad decision," says Wachovia chief economist Mark Vitner. "Because the real impact of what they do between now and the next meeting won't be known for more than a year."

So far Bernanke has resisted the urge to cut the federal funds rate from 5.25%, a move many on Wall Street would like to see happen to ease the credit crunch that has gripped global markets.

Instead, he has pumped billions of dollars into the banking system, either through the Fed's open market operations or via its discount window. Loans through the discount window are being encouraged, more so with the Fed's recent cut in the discount rate, to 5.75%. Bernanke seems to be relying on big U.S. banks to sort out the near-term solution.

But the volatility still remains, and concerns about the mortgage lending market--the source of the problems--continue to mount. The Dow Jones industrial average has been on a roller-coaster ride for more than two weeks.

Some lawmakers are calling on regulators to act. In a letter to U.S. Sen. Charles Schumer of New York earlier this week, Bernanke said the Fed was "prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets."

The Fed chairman traditionally speaks at the annual Fed conference, now in its 31st year. Attendees include central bankers from around the globe. The conference isn't supposed to be focused on short-term issues but instead on the longer term.

Last year, it was Bernanke's first appearance since taking over the Fed job. And by then he had already learned that what he says can move markets. In the spring, comments about interest rates on two separate occasions were interpreted as Bernanke being alternatively hawkish and dovish on inflation.

Instead of talking about interest rates, his speech at Jackson Hole last year was about ending protectionism. It was just weeks after the Fed halted a string of 17 straight interest rate increases over two years, holding the fed funds rate at 5.25%. Back then, the Fed said it saw signs of slower growth that may moderate inflation pressures. What a difference a year makes.

[bruinbirdman]

Anyone giving odds? I say no cut.

[Clique]

Someone tell me, please—

If they lower the federal funds rate, does it automatically follow that the prime rate will also go down?

Or are those two necessisarily connected?

[Regulator]

Instead of talking about interest rates, his speech at Jackson Hole last year was about ending protectionism

I agree.

Let's end the Federal Reserve monopoly now.

They've been protected for far too long.

[Eyes Unclouded]

He shouldn’t give a cut... but he will.

[Nervous Tick]

My guess is, no cut. Not in September, anyway.

Market forces seem to be taking hold on their own (e.g. BAC & Countrywide).

Hope it’s not just wishful thinking on my part, but it seems to be grounded in principle. Despite the so-called “credit crunch” there is still upward pressure on prices WW.

[bruinbirdman]

"still upward pressure on prices WW."

ECB dished out plenty euros. They are talking about raising rates.

yitbos

[knarf]

... but give them Arpege.

[Moonman62]

If they lower the federal funds rate, does it automatically follow that the prime rate will also go down? Or are those two necessisarily connected?

The two do move together. I don't think I would call it automatic, but banks do tie their prime rates to the funds rate.

[Moonman62]

ECB dished out plenty euros. They are talking about raising rates.

Central banks everywhere are fighting oil prices with higher interest rates. It's a stupid thing to do.

[Nervous Tick]

ECB dished out plenty euros. They are talking about raising rates.

It's a hot topic in Japan, also.

[Nervous Tick]

>> Central banks everywhere are fighting oil prices with higher interest rates. It’s a stupid thing to do.

Please explain why it’s a stupid thing to do.

[bruinbirdman]

"but banks do tie their prime rates to the funds rate."

Something like "our prime rate is Fed + 1%" depending on who you are or who you know. I think more usual is "Libor + ?%".

yitbos

[bruinbirdman]

OK - so I looked it up at MoneyCafe.

What is the Prime Rate? The Prime Interest Rate is the interest rate charged by banks to their most creditworthy customers (usually the most prominent and stable business customers). The rate is almost always the same amongst major banks. Adjustments to the prime lending rate are made by banks at the same time; although, the prime rate does not adjust on any regular basis. The rates reported below are based upon the prime rates on the first day of each respective month.

Federal Discount Rate - What it means: The interest rate at which an eligible financial institution may borrow funds directly from a Federal Reserve bank. Banks whose reserves dip below the reserve requirement set by the Federal Reserve's board of governors use that money to correct their shortage. The board of directors of each reserve bank sets the discount rate every 14 days. It's considered the last resort for banks, which usually borrow from each other. How it's used: The Fed uses the discount rate to control the supply of available funds, which in turn influences inflation and overall interest rates. The more money available, the more likely inflation will occur. Raising the rate makes it more expensive to borrow from the Fed. That lowers the supply of available money, which increases the short-term interest rates. Lowering the rate has the opposite effect, bringing short-term interest rates down.

yitbos

[Moonman62]

It’s stupid because oil prices don’t cause inflation.

[Nervous Tick]

OK, let’s take a different tack.

You said,

>> Central banks everywhere are fighting oil prices with higher interest rates. It’s a stupid thing to do.

Then you said,

>> It’s stupid because oil prices don’t cause inflation.

That hinges on your assertion that central banks are fighting “oil prices” with higher interest rates.

Do you have any support for that assertion? Can you point me to a link that gives evidence that central bankers claim higher interest rates are “fighting oil prices”?

Because I think CB are fighting CORE INFLATION (not “oil prices”) with higher interest rates.

[Moonman62]

First off, it's well known that central banks blame their economies for inflation. Economic growth and low unemployment are usually their targets. Looking at Europe, growth is lackluster, and unemployment is still high, yet they are hiking rates. There is no other cause except oil prices.

But it really doesn't matter whether I am right about their reason for hiking rates. What matters is that central banks are ineffective at fighting inflation, because they operate on the incorrect theory that the source of inflation is economic, whether it's low unemployment or oil prices, or something else.

Here is a chart documenting the Federal Reserve's failure. It should be noted that the FOMC started operations in 1936, and promptly caused a recession because it incorrectly feared that ample gold reserves would cause inflation.

[Nervous Tick]

Thanks for taking the time to post a thoughtful response.

I see that you and I have a difference in opinion re: the role and effectiveness of a central bank. We’ll probably have to agree to disagree, but I’ll remain interested in your informed opinion.

By the way, you say:

>> Looking at Europe, growth is lackluster, and unemployment is still high, yet they are hiking rates.

That’s true in part, but not uniformly throughout Europe. Germany, for example, has held the line on wage cost and is experiencing decent growth and even shows some progress on unemployment. Germany is a significant factor in the entire EU economy.