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Fed Was `Premature’ to Cut Rates, Former Central Banker Says - Pacific Research Institute

Fed Was `Premature’ to Cut Rates, Former Central Banker Says

Jan. 22 (Bloomberg) — The Federal Reserve was too quick to reduce interest rates today in an emergency move after global stock markets tumbled, a former Fed president said.

“It strikes me as very premature,” Lee Hoskins, former president of the Cleveland Fed, said in an interview after the central bank trimmed the benchmark interest rate by three quarters of a percentage point. “We have no new economic data coming in to warrant this kind of a move.”

The central bank cut the target overnight lending rate to 3.5 percent from 4.25 percent, its first emergency reduction since 2001 and the biggest trim since the Fed began using the rate as the principal tool of monetary policy around 1990. Policy makers weren’t scheduled to meet until next week.

“Broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households,” the Federal Open Market Committee said in a statement in Washington. The FOMC also cited “a weakening of the economic outlook and increasing downside risks to growth.”

Yesterday, almost half of the world’s biggest stock indexes fell into a bear market as mounting concern about a U.S. recession dragged down banking and retail shares across Asia, Europe and Latin America.

“The Fed is not supposed to be in the business of damping volatility in the stock market,” said Hoskins, now senior fellow at the Pacific Research Institute in San Francisco. The central bank is “basically trying to influence market psychology, and that is a weak foundation for Federal Reserve policy.”

Paulson Reaction

Treasury Secretary Henry Paulson endorsed the action, calling the Fed’s move “very constructive” and a “confidence builder.” He also said it was a sign to the rest of the world that the U.S. central bank is “nimble.”

The Fed, by cutting rates ahead of its meeting, signaled that it has grown increasingly concerned over banks’ reluctance to provide credit to companies and consumers, restrictions that may exacerbate an already slowing economy.

The central bank also changed its assessment of the housing slump in today’s statement to a “contraction” from a “correction,” the word the FOMC had been using since August. It also acknowledged “some softening in labor markets.”

Paulson was told by President George W. Bush last week to negotiate with lawmakers a fiscal stimulus plan of as much as $150 billion to help avert a recession.

Hoskins said it is “possible” that Fed policy makers were also under pressure, given that this is an election year, to respond to concerns about the housing market meltdown and lack of adequate regulation in credit markets.

“I hate to think that the Fed is concerned about political events,” Hoskins said. The Fed is “a political animal. It has to worry about its independence.”

Still, “it is a troubling time for the Fed, when you have an election coming up,” he said. “They do not want to look like they favor one party or another.”

To contact the reporter on this story: Shobhana Chandra in Washington schandra1@bloomberg.net

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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