Willem Buiter, Anne Siebert, and Walter Bagehot
Perpetual War and Perpetual Stupidity

John Berry Says that the Fed *Might*--Not *Will*--Cut Interest Rates

The Fed doesn't want to be locked in to any particular policy path right now:

Commentary by John M. Berry: Aug. 21 (Bloomberg) -- Federal Reserve policy makers haven't acted hastily in dealing with the financial market upheavals of the past two weeks, and they aren't going to. Neither the U.S. nor the world economy is collapsing, so Fed officials are doing exactly what they should be doing now: taking measured steps to ensure that creditworthy borrowers can get credit.

Whether the Fed's 5.25 percent target for the overnight lending rate gets cut in coming weeks will depend on how soon markets stabilize and how much the outlook for growth turns out to deteriorate. The Fed has added liquidity to the financial system through open market operations, and on Aug. 17 it announced a 50-basis point cut in the discount rate, to 5.75 percent. Moreover, in a highly unusual conference call, officials encouraged banks to borrow at the regional Fed banks' discount windows for 30 days or longer rather than just overnight....

The discount rate cut and the encouragement to borrow were intended "to ensure the smooth functioning of the financial system," Jen said. The [FOMC statement] was "to properly respond to changing risks to growth and inflation" without promising a series of rate cuts....

Economists at Deutsche Bank Securities drew a parallel between this market turmoil and the stock market crash of October 1987.... This time around... if central banks "make it clear that they stand ready to keep credit open to credit-worthy borrowers, there is still a chance that the dynamics of 1987 will reassert themselves, leading to a stabilization of markets and a continuation of the world economic expansion."...

The remarkable -- though not unprecedented -- thing about the past two weeks is how doubts about the scope of losses on securities backed by packages of subprime mortgages spread fear throughout credit markets. At $50 billion to $250 billion, the estimated likely losses associated with the default of U.S. subprime borrowers are small compared with the assets of private investors and commercial banks.... "Corporate balance sheets are healthy," Geithner said. "The six-month trailing bond default rate has stayed near zero this year, and the delinquency rate on commercial and industrial loans at banks remains extremely low."

All of that is still true. It may not remain so.... [Nevertheless the] real economy hasn't gone into the ditch... a lot of assets remain ``fundamentally sound'' and moral hazard is a very real issue. So the Fed is taking only measured steps while ready to do more if necessary.

Since I was a rate cutter three months ago, I'm even more of a rate cutter now. But I can see how a FOMC that wasn't a rate cutter three months ago might not want to cut rates the next time it meets.