The Federal Reserve has been in no hurry to cut the benchmark federal-funds rate because it wants to counter an investor perception that the Fed is there to bail out the markets, the Wall Street Journal reported Thursday. Journalist Greg Ip explains that the Fed has two primary roles: 1) to maintain financial stability; and 2) to maintain macroeconomic stability by controlling inflation and averting recession. Former Fed Chairman Alan Greenspan conflated the two, notably by cutting rates after the 1987 market crash and the 1998 near-collapse of hedge fund Long-Term Capital Management. Those cuts were intended to reassure investors that it remained safe to take risks, thus protecting the economy's growth prospects. Current Fed Chairman Ben Bernanke, on the other hand, distinguishes more sharply between the Fed's responsibilities. On August 17, the Fed cut the discount window rate but not the federal-funds rate -- a move intended to smooth the waters in the turbulent credit markets but not to boost growth. "There's no doubt they were trying to draw a distinction between using the main tool of monetary policy, which is the federal-funds rate, and aiming the discount rate at restoring the plumbing," said former Fed vice chairman Alan Blinder. Ip contends that Bernanke is trying to correct the "moral hazard" implicit in Greenspan's interventionist approach, which "encourag[ed] investors to act more recklessly because they [thought] the Fed will protect them."
Sources: Wall Street Journal, Reuters
Commentary: Mortgage Lenders Don't Need More Help From Fannie and Freddie -- Bernanke • Markets Watch the Fed — What Does the Fed Watch? • Fed Weighed Policy Action Ten Days Prior to Rate Cut
Stocks/ETFs to watch: SPY, AGG, DIA
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