Gertler says Fed criticism is "way overboard"

From the Wall St. Journal Real Time Economics Blog comes this comment from Mark Gertler,

Now why did the Fed have to move on Tuesday — why not wait until the next FOMC meeting? To date, the Fed has done a good job of separating the explicit timing of funds rate cuts from stock price declines (e.g. witness last August). However, given the weakened state of financial institutions, a sharp asset price contraction had the potential to significantly disrupt credit flows and thus do significant harm to the real economy. The Fed action offset this potentially disruptive chain of events. Of course, we can’t do the counterfactual of examining what would have happened had the Fed done nothing (just as we can’t for the intervention last August). But many would agree that a real disaster might have ensued.

Read the whole thing. Gertler has a point. And so here we are at the beginning of a two day FOMC meeting waiting to see if there will be another cut tomorrow and how much it will be. The market seems torn between 25 and 50 basis points. 25 seem the most reasonable (though not necessarily the most likely) to me at the moment, but I certainly wouldn't rule out 50.

Much ink has been spilled and many pixels have been lit up over the 75 basis point move last week. Like you, I've been thinking a lot about it, but I have been reserving judgment. I have to admit that the timing of the move was a surprise. In the days leading up to the cut, I had been leaning towards a 50 to 75 basis point move at this week's meeting, but if I had been in the chair I would have wanted to avoid pulling the trigger right before a scheduled meeting. No doubt Mr. Bernanke would have wanted to avoid it too, if we were in a perfect world. So as an outside observer, I have to believe that Mr. Bernanke's main concern at that moment last week was the potential for a financial shock that would have immediate and long lasting impact on the real economy--a financial accelerator, to use the term that he used this summer. Real Time Economics also pointed this out at the end of last week.

So if the move last week was a calculated effort to cushion the financial markets to prevent such a shock, it may have worked, at least temporarily. The problem, and Mr. Bernanke no doubt knows this all too well, is that he spent a good bit of his ammunition on this one. The odds that there will be another in the near future are probably better than 2 to 1. I don't know many people who think that all the ugly surprises have been revealed. Even if the economy can technically avoid a recession (which it still may), we're still in for a bit of a bumpy ride. Another intermeeting cut in '08 is not out of the question.

And while I have tended to the hawkish side throughout the last couple of years, I agree with the general easing of monetary policy in recent weeks. It's a policy of containment. But I would also like to see rates go up more quickly (no more measured pace) when the current troubles have subsided.

I don't see last week's move as a case of "propping up" the market except to the extent that it may have bought the market some time to work things out. If you buy into the financial accelerator theory, that's not necessarily a bad thing. What remains to be seen is how well the Fed can transition back to a more balanced (i.e. more concerned about inflation) policy stance. I'm not 100% optimistic. I worry that the markets will get addicted to the rate cuts just as voters get addicted to fiscal stimulus. There's a Kydland and Prescott result lurking around here somewhere and I'm not sure it has a happy ending.

But this week, those concerns are pushed to the back burner, for better or for worse. While I agree with Gertler in the context of the near term concerns, I just wish that this policy stance didn't have the lasting ramifications that I fear it does. I hope that the Fed did not choose the lesser of two evils only to wind up with both. Only time will tell.