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Is Bernanke a Rate Chopper?

The market expects a fed funds cut, but some warn nothing is a given.

An offhand remark continues to hover noisily over Ben Bernanke's stewardship of the

Federal Reserve


As a Fed governor in 2002, Bernanke famously offered how the central bank could keep wages and prices from falling into a damaging deflationary spiral. He said the Fed could drop money into the economy with helicopters.

The comment infuriated Fed critics who believe the bank has been all too willing to debase the value of the dollar, and the name "Helicopter Ben" quickly took hold. Yet since taking over for Alan Greenspan last year, Bernanke has been anything but a dove, surprising some observers by holding the fed funds overnight lending target steady at 5.25%.

So as the next Fed meeting looms -- the policy-setting Federal Open Market Committee is due to meet Sept. 18 -- Bernanke isn't just leading a contentious debate with hefty implications for the economy. While some economists expect the Fed to cut rates to fend off a potential financial catastrophe, others believe Bernanke is inclined to hold the line.

Possibly shaping the Fed's stance is the institution's desire to show it's independent -- and to finally drown out one ill-advised comment Bernanke made five years ago.

"The Fed would really regret easing and creating an environment where they lower the funds rate, the dollar makes new lows, commodity prices make new highs, and credit spreads narrow to historically tight levels again," says Michael Darda, chief economist at MKM Partners. "Then the Fed creates the credibility problem where the Fed looks like they overreacted."

Most agree the Fed has finally opened the door to rate cuts, after more than a year of steady rates. Last month, the Fed cut the penalty charged at its discount window and, along with other central banks, injected large amounts of liquidity into the financial system. The move was seen as a balm for troubled financial players ranging from

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Then, on Friday, in a speech at the Federal Reserve Bank of Kansas City's Economic Symposium in Jackson Hole, Wyo., Bernanke signaled he is taking very seriously the threats to economic growth.

"Bernanke had a chance to dissuade markets the Fed would ease and he didn't," says Ethan Harris, chief economist at Lehman Brothers. "If he had wanted to do so, he'd have talked more about moral hazard risks or inflation concerns, and he didn't do either. ... He put to the back row the two major impediments to an easing."

Bernanke said "developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy."

Bernanke noted that in light of a credit crunch that has hammered the commercial paper and mortage securities markets, among others, "economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation." He added, "We will pay particularly close attention to the timeliest indicators," in addition to contacts in the market.

So, Bernanke's mantra that the Fed is just as data-dependent as ever and not an oracle of economic truth remains.

What the Fed will be looking at is the weekly initial jobless claims, which have trended slightly higher of late. This week's come out Thursday. The Fed is also watching the floundering dollar and the still-high price of commodities and gold, which, while off their highs, still reflect strong economic growth and ample liquidity around the world.

Indeed, the International Monetary Fund has only shaved just over 0.1 percentage point from its 2007 global economic growth forecast since this credit crisis began. The IMF's view is for 5.2% worldwide growth.

The markets believe a 25-basis-point cut on the fed funds rate to 5% is a foregone conclusion. But that's a dangerous bet with Bernanke, says Art Hogan, chief market analyst at Jefferies & Co.

He noted that last May, the markets were convinced -- wrongly -- that the Fed would not raise rates for a third time under Bernanke's watch, which began at the start of 2006. The market fell sharply in May of 2006 and continued to slump until it bottomed in August of last year.

"This year's August low in the stock market is predicated on the Fed doing something we're not sure they're going to do," warns Hogan.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


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