Perhaps the Fed is worried about the financial markets in their own right. On the eve of this cut, Nasdaq was down 55% from its peak last year. This has hurt a lot of investors. On the other hand, the broader market had fallen much less, and anyway it would be plain wrong to cut interest rates in order to push tech-stock valuations, many of which are still too high, back up. Keeping a bubble inflated is hardly a job for monetary policy. Elsewhere in the financial system, the creaking noises are getting louder. Credit markets are drying up, as investors flee risk, making it harder and more expensive for many firms to borrow. Spreads between junk bonds and risk-free Treasury bonds have increased to their widest since the 1991 recession, wider even than in 1998, circa LTCM. The market for initial public offerings has more or less closed, and banks have tightened their lending standards to firms as past loans have begun to turn bad. All this is worrying—but these are exactly the sorts of stresses that will be worsened, except in the short term, by a panicky easing of policy.
Mr Greenspan, an enormously able and experienced man, is undoubtedly aware of these risks. And yet he seems far more willing, as throughout his time as Fed chairman, to cut rates than to raise them. (Most of his critics, we acknowledge, attack him for exactly the opposite reason, but then we have always had far more respect for Mr Greenspan than for those critics [lol!].) Still, one cannot help wondering whether the Fed knows something the rest of us do not about financial fragility in America. Perhaps some specific, impending and possibly contagious calamity, another LTCM, needs to be headed off. If so, the markets will presumably soon regret their spasm of exuberance on January 3rd—and we will soon applaud the Fed’s prompt, not precipitate, action in cutting rates. Barring such alarming possibilities, the Fed’s haste is difficult to understand and even more difficult to defend.
[Full text at http://www.economist.com/displayStory.cfm?story_ID=468221]
Carl
_________________________________________________________________ Get your FREE download of MSN Explorer at http://explorer.msn.com