Bernanke's Helicopter Drop Cometh

♠ Posted by Emmanuel in at 8/17/2007 03:11:00 PM
Well, well, well, it seems that B-B-B-Bennie of the Feds has begun to put into operation the long-rumored "helicopter drop" he alluded to in an earlier speech. The Federal Reserve has decided to cut the discount rate--the rate at which regional Fed banks lend to financial institutions to cover their reserve requirements--from 6.25% to 5.75%. To me, there is no mystery here. Financial institutions that have been behaving badly by engaging in all sorts of subprime and private-equity tomfoolery are being bailed out by the Fed. Talk about rewarding poor behavior; the Greenspan put has morphed into the Bernanke put. Meet the new boss, same as the old boss. As I've mentioned (see my sixth point), the subprime mess offers precious few lessons.

Just a few days ago, the Economist lauded Bernanke for standing pat on interest rates at the most recent Federal Reserve Open Market Committee (FOMC) meeting and not giving in to pressures to cut rates. I guess it's IPE Zone 1, Economist 0 (for now). Have a chuckle here:
Call Ben Bernanke easy and he might slap your face. The chief of the Federal Reserve and his colleagues left America’s benchmark interest rate unchanged at 5.25% [the federal funds rate at which commercial banks lend to each other, not the discount rate at which the regional Feds lend] after meeting on Tuesday August 7th. America’s rate-setters gave little indication that they were minded to cut rates any time soon. The Fed acknowledged that financial markets had been volatile, credit conditions had tightened and core inflation had “improved modestly”. But it stressed that the economy was still on course for moderate growth, albeit with greater downside risks, and that inflation remains the main policy concern...

The Fed is rightly reluctant to signal rate cuts at the first sign of turbulence in the markets. An institution that has been criticised for not tightening more aggressively during the housing boom should not want to encourage excessive risk-taking now. Inflation, if it shoves up interest rates, is arguably the biggest worry for a debt-laden economy, although concern about the impact of the housing downturn is growing. Deepening economic gloom may well mean interest-rate cuts will prove necessary to arrest a sharper downturn. But for now, Mr Bernanke is right to play hard to get.
UPDATE: I hate to gloat, but it seems even BusinessWeek was portraying ol' Helicopter Ben as an inflation hawk, a pillar of confidence, etc:
Cool, calm, and collected, Federal Reserve Chairman Ben Bernanke is driving Wall Street batty. When traders scream about a recessionary "credit crunch," the former professor acknowledges their concerns but predicts continued economic growth. When they plead for easier money, Bernanke and his fellow rate-setters firmly hold the line. "Scandalous," sputtered one North Carolina market strategist. Jim Cramer, the TV stockpicker, nearly melted in a pool of his own sweat on a recent program, saying Bernanke must flood the system with money to stop financial Armageddon. Shouted Cramer: "He has no idea how bad it is out there!"

The Street may be dismayed by Bernanke's sangfroid, but it shouldn't be surprised. This is exactly the kind of policy that Bernanke has spent his entire career arguing for. At Princeton University, where Bernanke taught from 1985 to 2002, he said central bankers should avoid getting caught up in the gyrations of the financial markets and focus instead on measures of the real economy, such as growth and inflation. He said the Fed should set a target rate for inflation and then steer monetary policy to hit that target—an approach that would change central bankers from financial demigods into something more like engineers...