Having said this, the main worry unmentioned in the report, is that drying liquidity and risk concerns might threat the solvency of the banking system. This is the greatest worry against which the Fed is called to act promptly. Actually not only the Fed but any central bank. We have seen some of this today when liquidity has dried up in money markets pushing the 3 months rate to 5, 5 % in the US and 4, 31 % in Europe. While the 3 months money market rate was moving towards 5, 5 % in the US, the Fed fund futures was moving in opposite direction (pricing increasing probabilities of an easing). Hence the premium in the money markets was just a risk premium on the credit condition concerns. The ECB and the Federal Reserve have both reacted aggressively providing the needed liquidity. Hence the central banks both in Europe and the US have acted appropriately. But should they go as far as to cut rates as suggested in the US? Remember that a week ago Trichet already suggested further hikes in Europe.

Members of the Fed have provided solid arguments on why they should not promptly cut rates and respond to any market upset. William Poole from St.Louis Fed argues that “ if the Fed market believes that the Fed is always primed to adjust policy, then market participants will spend more time trying to second guess the Fed than trying to understand what is happening in the economy”. The Fed wants to make sure that they do not create a “moral hazard” problem for the future. They can not bail out any institution that has made reckless investments. The Fed will only cut rates if the current tightness evolves endangering the health of the financial system or affecting growth. The famous Greenspan put option seems to have been put aside and will only be used if really needed.