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Is the Fed cutting rates too slowly?

Fed Chairman Ben Bernanke is coming under criticism from some analysts who think the central bank has moved too slowly on interest rates to head off the downturn.
Image: US Chairman of the Federal Reserve Ben Bernanke at House Budget Committee on Capitol Hill
U.S. Chairman of the Federal Reserve Ben Bernanke testifies before a House Budget Committee hearing on "The Near-Term Outlook for the U.S. Economy" on Capitol Hill. Jim Young / Reuters
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Federal Reserve Chairman Ben Bernanke added his voice Thursday to a growing chorus of those who support proposals to boost the stumbling economy through federal tax cuts or spending increases. But at the same time he is coming under criticism from some analysts who think the Fed has moved too slowly on interest rates to head off the downturn.

Bernanke appeared before the House Budget Committee and backed the general idea of a stimulus plan, which also won support from the White House Thursday. With a majority of likely voters now saying the economy is the No. 1 issue facing the country in this presidential election year, efforts have intensified to get a bill onto President Bush's desk.

With pressure for a government stimulus package mounting on Capitol Hill and on the campaign trail, the White House said Thursday that Bush would lay out the principles behind his idea of a new economic stimulus package on Friday. Bush told congressional leaders privately on Thursday he favors personal income tax rebates and tax breaks for businesses to help avert a recession, officials said.

But it’s widely acknowledged that the Fed itself needs to do the heavy lifting by continuing to lower interest rates, which it began doing in September.

“The Fed just should act a lot faster than they have been acting,” said former Fed Gov.  Robert Heller. “Just to do that old Greenpsan one-quarter baby step at a time, in the current situation, doesn’t do the trick. The Fed has been behind the curve for three-quarters of a year now.”

Every Fed has a mix of hawks and doves — those who favor keeping rates a bit on the high side vs. those who want them as low as possible. But Bernanke’s critics say that, in addition to moving too slowly, the Fed has given mixed signals about its rate policy from one meeting to the next.

After holding rates steady beginning in June 2006, the Fed came under pressure to cut rates last year after it became clear that the housing bubble had burst. Yet the central bank held rates steady at its August meeting even as investor fears about bad loans all but shut down credit markets. The Fed made up for lost ground with a half-point cut in September, then added quarter-point cuts in October and December.

Today forecasters are widely expecting a half-point cut in benchmark rates when Fed policymakers meet Jan. 30, and Bernanke recently has been outspoken about the Fed’s intention to cut rates further.

Some of the criticism of the Bernanke Fed has focused on the style and actions of the chairman himself, who has been in office two years. No one doubts Bernanke’s qualifications for his current role; as a distinguished academic economist, he is one of the foremost experts on the causes of the Great Depression and the Fed’s role in managing economic downturns. But some say his management style may be a little too collegial for the current crisis.

As a Princeton University department chair, Bernanke developed a knack for building consensus – not always an easy task with the 12 independent-minded members of the Fed’s rate-setting Open Market Committee. Though his predecessor Alan Greenspan opened meetings with his own recommendations and then took comments from around the table, Bernanke is said to hear out the rest of the committee before weighing in with his own views. That consensus strengthens the Fed’s decisions, but critics say it may also slow the central bank’s response to crisis.

“They call him Gentle Ben,” said Heller. “But he clearly has to build a consensus in the committee.  If votes turned out to be 7 to 5 you would hear people saying, ‘Oh my God. He doesn’t get the other people on board.’”

Former Fed officials also note that members of the rate-setting committee generally work from the same economic data and analysis provided by the central bank’s research department.

Much of the criticism of the Fed has been coming from Wall Street, where easy-money policies could help take some of the sting out of the roughly $100 billion in losses from bad lending decisions during the housing bubble. But Bernanke has said he is not overly concerned with those views.

“It’s not the Federal Reserve’s job to protect investors from the decisions they made,” Bernanke told the budget committee Thursday.

In fact, pressure from Wall Street to cut rates may be having the opposite effect, according to Robert McTeer, who retired in 2005 as president of the Dallas Fed, one of 12 regional banks that make up the Federal Reserve system.

“The market keeps dictating to the Fed what the Fed ought to be doing – and the Fed doesn’t like that,” said McTeer. “The Fed likes to feel likes it's using its own judgment and it doesn’t like to be boxed in. That’s probably why (Bernanke’s) not cutting rates outside the regular meeting cycle. He may think they need to be cut today, but it would be just one more example of the Fed being jerked around by the market.”

Bernanke’s defenders also note that until recently, a policy of aggressive rate cuts wasn’t necessarily a no-brainer. Even as the credit markets were in turmoil last August, the economy was turning in solid 3.9 percent annual growth for the third quarter and the job market was relatively strong.

It’s also not clear that cutting rates and pushing more money into the financial system would have prevented the credit crunch that is weighing on the economy. Money has gotten tighter mainly because lenders and investors are worried about parting with their money — at any price.

“People are afraid they won’t be repaid when they lend money," said McTeer. “If you worried about being repaid, a quarter-point, half-point or even a whole point difference in the interest rate is meaningless to you. “

Avoiding recessions — and keeping employment levels high — is only one of the Fed’s twin mandates. The other is maintaining stable prices, a goal that is foremost in the minds of anyone — including Bernanke — who lived through the prolonged and painful inflation of the 1970s. Though inflation is relatively tame, rising food and energy prices have begun to push so-called "core inflation" above the Fed’s target range of 1 to 2 percent.

“The Fed’s basic job is prevent a resurgence in inflation, and while you still have a few people out there saying that inflation is not a problem – that’s just not true,” said Alfred Broaddus, former president of the Richmond Fed. “The Fed's reluctance up until now to really drop the rate, say a full point in one meeting, is because of that constraint.”

While the Fed can soften the impact of recessions, it can’t always prevent them from happening. Some Fed watchers say recessions are an important part of the business cycle; by periodically flushing out speculation and unproductive businesses, the economy builds a firm base to promote stronger future growth.

“The public should not expect the Fed to be fine-tuning the economy with monetary policy and avoiding all recessions and ending the business cycle,” said Broaddus.

For now, the Fed is acknowledging it could use some help. Bernanke told the budget committee Thursday that an emergency stimulus package could help — but only if Congress gets it right. Such a package has to come soon enough give the economy a quick boost without adding to the budget deficit; otherwise it could do more harm than good, Bernanke said.

But the success of any fiscal stimulus package from Congress rests heavily on whether the Fed has gotten it right with its monetary policy setting interest rates, according to McTeer.

“The impact of fiscal policy depends on monetary policy being correct,” he said. “But if monetary policy is correct you probably don’t need fiscal policy.”