What's Behind the Fed's Aggressive Interest-Rate Cut?
On Tuesday September 18, US central bank policy makers surprised financial market players by cutting the federal funds rate target by 0.5% to 4.75%.
The key motivating factor behind the hefty cut in the federal funds rate target was an economic model that Fed Chairman Ben Bernanke developed while in academia.
Bernanke is of the view that changes in financial and credit conditions are important in the propagation of the business cycle through a mechanism that he dubbed the "financial accelerator."
In his view, it is by means of the "financial accelerator" that a sudden short-lived disruption in financial markets can set in motion a prolonged disruptive and amplified effect on the real economy.
The question that must be asked is what gives rise to the emergence of such conditions? Disruptions in financial markets do not emerge out of the blue.
We suggest that the major cause that sets these disruptions in motion is likely to be the central bank itself. FULL ARTICLE
Comments (4)
Jordan
Ah, the Fed.
The cause of--and solution to--all of life's problems.
Published: October 23, 2007 8:49 AM
Fundamentalist
Very interest summary of Bernanke's business cycle theory. It sounds like a detailed version of Friedman's dip theory in which the economy follows a straight, upward path but occasionally runs into dips. The Fed's job is to fill in the dips.
Bernanke may have some valid points about how finance and the economy work after the recession has started, but I can't believe he still blaims "shocks" for starting the problem. Calling the causes of economic problems shocks may sound sophisticated, but it's nothing more than saying "it happens and we don't know why."
Bernanke can't help but arrive at his thesis while holding to Friedman's believe that monetary inflation just lifts all prices across the board; it does no harm. It must be a very comforting for Fed Chairmen to believe that they can do no harm, only good, and can always rescue capitalism from its natural instability caused by "shocks".
Published: October 23, 2007 12:21 PM
Anthony
Fundamentalist, we're still taught that shocks are responsible for the business cycle in undergrad courses. Well, of course, nowadays the real business cycle theory is taught as well.
Published: October 23, 2007 7:08 PM
DickF
This was a very interesting article. I was not aware of Bernanke's business cycle theory, but it does explain the actions of the FED.
I am watching the actions of the FED with much greater interest now because if this is what they are doing and the ABCT is real (what I believe) then we are in for some of the greatest swings our economy has ever seen. Greenspan has us on a roller coaster; it looks like with Bernanke it is a bungee jump.
Published: October 24, 2007 10:47 AM