Federal Reserve Vice Chairman Donald Kohn defended the central bank's aggressive interest-rate cut, saying it was driven by concerns about the broader economy rather than an interest in protecting investors or the value of housing.
And fellow Fed Governor Kevin Warsh said the Fed's next move depends on economic events, rather than on financial markets. "The goal of our policy...is not to look at any particular asset class" but instead is to watch "what's happening in the real economy," Mr. Warsh said after a speech at the State University of New York at Albany. "We are going to stay very closely focused on real-time indicators and forward indicators."
I don't want to sound unsympathetic to the Fed's point; there are troubling signs coming from the economy.
However, I don't think I'm alone in being very confused by the divergence between the Fed's statements and their action. Up until August 7 the Fed's public statements were "we're more concerned about inflation than threats to growth." However, between August 7 and the rate cut last week something obviously changed. The Fed not only cut rates, but cut them sharply. This action was very much out of character with their previous statements, which sounded very cautious regarding policy.
It's entirely likely the Fed was putting on a united front about the economy until August 7 and after. They are after all some of the leading people we look to about what is happening. They can't appear to be scared. And Fed jawboning can have an impact on people's psychology. After all, if the Fed says things are OK, maybe they know something that we don't.
But the size of the cut just doesn't jibe with a calm and reasoned outlook. Until last week, the Fed's actions were very prudent. First, they had injected liquidity into the market. Then they cut the discount rate -- a rate specifically target to the financial markets. The Fed was acting very responsibly. Mose importantly, they were acting maturely. Their actions were slow but deliberate.
Last week's action looks very much like a "holy shit" variety. Instead of looking reasoned and responsible, the Fed is looking like they are desperately trying to play catch-up with a situation that is getting out of hand. In short, the Fed looks like they are behind the curve rather than driving it. And that gives me a great deal of concern about this Fed's ability to steer the economy.
