The Wall Street Journal-20080124-CAPITAL- Speed and Restraint Are Crucial
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CAPITAL: Speed and Restraint Are Crucial
And now? President Bush and congressional Democrats are so worried they're making nice for the first time since Sept. 11, 2001. Two years into his term as Federal Reserve chairman, taciturn Ben Bernanke is pushing the emergency button. On top of earlier concerns about falling home prices, disruptions in credit markets and banks too shellshocked to lend, the U.S. economy now confronts a falling stock market and the prospect of a really nasty recession.
Yikes. Are politicians and the Fed panicking and doing too much? Or are they doing too little, too late?
We won't know for sure until we see how this story ends, but a couple of things are clear.
The government -- from the White House and Congress to state and federal regulators and the Fed -- should have and could have moved sooner to restrain aggressive marketing of lousy mortgages to people who couldn't afford them, as well as incentives that encouraged shortsighted risk-taking on Wall Street. Government didn't cause these excesses, but government is supposed to provide the guardrails in modern capitalism.
And the brightest minds at the Fed (whose forecasts matter) and the rest of the government didn't expect the economy to be as bad as it's turning out to be. They -- like most of Wall Street -- got it wrong. That isn't a communication problem; it's a forecasting blunder.
Politicians of both parties, at least the ones already in office, are rushing toward fiscal stimulus, defying the once-conventional wisdom that they would argue, rather than compromise. With the economic headlines frightening and their standing in the polls lousy, Mr. Bush and Congress want to be seen as part of the solution. (It would be comforting if they would show similar urgency on their backlog of big problems: Social Security, health care, education, the vulnerability of those who aren't enjoying benefits of globalization.)
The question is whether the White House and Congress can move swiftly enough, and restrain themselves from loading up a stimulus bill with all sorts of debris. Fiscal stimulus probably won't prevent a recession, but can moderate it. To be effective and prudent -- and it's an open question how effective it will be -- stimulus needs to be timely, targeted and temporary.
At the Fed, the first responder to recession, the issues are different. Mr. Bernanke and colleagues, appropriately, are cutting interest rates in response to a deteriorating economy and dissipating confidence. The trick is to do so in a way that enhances the Fed's credibility, the intangible quality that can either weaken or strengthen the impact of its interest-rate moves. To succeed, a central bank cannot look either klutzy or impotent.
Back in March 2001, when the economy was, we know now, in the first month of a recession, the Fed had cut interest rates by a full percentage point, and some officials were arguing for another cut of three-quarters of a percentage point, or 75 basis points in traders' jargon. Then-Fed Chairman Alan Greenspan resisted.
"I fear that with a reduction of 75 basis points . . . stock prices could still fall, leading too many observers to conclude that monetary policy is ineffective," transcripts record him saying. "This is a potentially dangerous view in my mind, especially among the broad array of those who do not participate in the equity markets. If we do 50 basis points and stock prices fall further . . . it is the central bankers who may be perceived as intellectually inadequate, not policy itself. This is far less dangerous to the economy! [Laughter]"
Mr. Greenspan's colleagues, as usual, heeded his advice. They cut rates by a half percentage point at that meeting, and stocks promptly tanked. The Fed cut rates again by another half point on April 18 and another half point on May 15. The recession was short and mild despite the terror of Sept. 11, though the recovery was maddeningly sluggish. A tax cut reinforced the Fed's rate-cutting. (Whether the Fed kept rates too low, too long is another matter.)
Today, a short, mild recession followed by a sluggish recovery looks downright appealing, given the gloomier scenarios floating around. Mr. Bernanke's challenge is to do what he thinks best with interest rates without creating the unhealthy impression that he is (a) being led by the stock market, (b) constantly scrambling to catch up with reality, or (c) unable to treat what ails the economy. That will be tricky.
Mr. Greenspan's timing was impeccable.
