Greg Ip: Bernanke Breaks Greenspan Mold
Ben Bernanke sends signals that interest rate cuts are not foreordained, and that orderly markets can be maintained without cutting rates:
Bernanke Breaks Greenspan Mold - WSJ.com: The Fed historically has had two major economic duties. Maintaining financial stability is one. Controlling inflation while preventing recession is the other. To Mr. Greenspan, market confidence and the economy's growth prospects were so intertwined as to make the Fed's two duties almost inseparable. He cut rates after the 1987 stock-market crash and the near-collapse of hedge fund Long-Term Capital Management in 1998 to prevent investor reluctance to take risks from undermining the nation's economic growth.
By contrast, Mr. Bernanke distinguishes between the central bank's two functions. So, on Aug. 17, the Fed cut the interest rate and lengthened the term on loans to banks from its little-used discount window in hopes banks would use the window -- or at least the knowledge it was available -- to lend to solid borrowers having trouble getting credit amidst the market turmoil. The action was aimed at restoring the normal functioning of disrupted credit markets, not primarily at boosting growth. The Fed, meanwhile, hasn't cut the far more economically important federal-funds rate, charged on loans between banks, which is the benchmark for all short-term U.S. borrowing costs.... "There's no doubt they were trying to draw a distinction between using the main tool of monetary policy, which is the federal-funds rate, and aiming the discount rate at restoring the plumbing," says Alan Blinder, a former Fed vice chairman....
Neither Mr. Bernanke nor his closest colleagues, some of whom served under Mr. Greenspan, believe there ever was a "Greenspan put," a reference to a contract that protects an investor from loss. Yet officials acknowledge the perception that the Fed has bailed out investors in the past. When the stock market crashed in 1987, Mr. Greenspan, then on the job for just two months, used aggressive open-market operations -- buying and selling government securities -- to pump banks full of cash, which caused the federal-funds rate to fall to about 6.75% from 7.25%. His priority was to keep banks well supplied with cash so that strapped securities dealers wouldn't fail for lack of financing....
Al Broaddus, research director and later president of the Federal Reserve Bank of Richmond during Mr. Greenspan's tenure, says Mr. Greenspan's response in 1987 was right. "A 20% drop in the stock market was a clear threat to economic conditions." But he says that in 1998, he and some others were skeptical of the need for such drastic action to deal with market instability. "If we could have argued for something like Bernanke is doing this time as opposed to three funds-rate reductions, we might have done that"...
