Today's Surprise Fed Funds Rate Cut

I find today's fed funds rate cut troubling. Since when does the Fed's mandate cover activity in global stock markets? And no, I do not buy the argument that the fall in global stock markets somehow represents brand new information--that did not exist a few days ago--about the possibility of a U.S. recession. The market sell off was pure panic driven and the irregular timing of this rate cut makes the Fed look panic driven too.

I really like Ben Bernanke, but this response blows my mind away. The only reasonable justification for such action is that the Fed knows something the markets do not know. If so, then the markets have even more reason to panic and sell off.

So how does Wall Street feel about this move? CNBC did a quick survey today and found,

"Nearly 75 percent of Wall Street pros responding to the CNBC Trillion Dollar Snap Survey think the Federal Reserve did the right thing by cutting interest rates by three-quarters of a point, to 3.5%, this morning."

Surprise, surprise. Stepping away from Wall Street, where the intoxicating influence of liquidityholics like Jim Cramer is hard to avoid, one can find more thoughtful observers. For example, Willem Buiter of the London School of Economics writes in Financial Times the following:

"It is bad news when the markets panic. It is worse news when one of the world's key monetary policy making institutions panics. Today the Fed cut the target for the Federal Funds Rate by 75 basis points, from 4.25 percent to 3.50 percent. The announcement was made outside normal hours and between normal scheduled FOMC meetings.

This extraordinary action was excessive and smells of fear. It is the clearest example of monetary policy panic football I have witnessed in more than thirty years as a professional economist. Because the action is so disproportionate, it is likely to further unsettle markets. Even the symptoms of malaise that appear to have triggered the Fed's irresponsible rate cut, the collapse of stock markets in Asia and Europe and the clear message from the futures markets that the US stock markets would follow (a 500 point decline of the Dow was indicated), are unlikely to be improved by this measure and may well be adversely affected.

In the absence of any other dramatic news that the sky is falling, I can only infer from the Fed's action that one or both of the following two propositions must be true.

(1) The Fed cares intrinsically about the stock market; specifically, it will use the instruments at its disposal to limit to the best of its ability any sudden decline in the stock market.

(2) The Fed believes that the global and (anticipate) domestic decline in stock prices either will have such a strong negative impact on the real economy or provides new information about future economic weakness from other sources, that its triple mandate (maximum employment, stable prices and moderate long-term interest rates) is best served by an out-of-sequence, out-of-hours rate cut of 75 basis points.

The first proposition would mean that the Fed violates its mandate. The second is bad economics."

Another example comes from Felix Salmon:

"There's nothing in there to justify a huge rate cut in the week before a regularly-scheduled meeting. Tighter credit for some households? Come on. There's one reason and one reason only that the Fed took this move, and it's the plunge in global stock markets on Monday, along with indications that the US markets were set to follow suit.

Now the Fed is charged with keeping employment high and inflation low; it's not charged with protecting the capital of investors in the stock market. So this action smells a bit like panic to me, and it might also have prevented the kind of stomach-lurching selling which could conceivably have marked a market bottom. I have to say I don't like it."

Sigh...