Ben Bernanke today cut the Fed Funds rate by 25 basis points to 4.25%. He refrained from cutting by 50 basis points which would have taken the Fed Funds rate to 4.00% as most of your talking heads on CNBC would have advocated.
Bernanke was correct not to overeact (or to continue to overeact) to the talking heads. While the economy is in fact slowing very slightly (we may have a mild recession) due to a nationwide housing price fall, employment remains strong. We don't need massive impetus to keep the economy afloat here.
Virtually every financial institutions wants a massive cut. For those banks that cannot understand their own balance sheets (Citi, Countrywide, etc.), lower rates will bail them out of their dreadful mortgage loan and SIV problems. For those more solid banks (Wells Fargo?), lower interest rates will provide a steeper yield curve that allows them to make more money.
We need not rescue the banks at risk of creating more serious problems. The more serious risk that the economy faces at this point is inflation. While much has been made about the fact that the Fed erroneously or conveniently focuses on the "core rate" (less food and energy), Ben Bernanke doesn't have his head completely in the sand. He sees that there is inflation all around. It is evident in soaring commodity prices, it is evident at the gas station it is evident at the grocery store and it is evident by the collapse (and, yes, it is a collapse) of the US dollar. And, Bernanke remembers that when he became Chairman of the Federal Reserve that he lectured Congress on the dangers of inflation and said that the Fed's core responsibility is to control it.
While Bernanke overeacted several months ago by cutting to aggressively, today's action indicates that the Fed may remain true to its purpose - to keep inflation in check - not rescue banks from their mistakes or subprime lenders from their ignorance.
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