Bernake is balancing carefully the tools he has available and targets he has been entrusted. The Federal Reserve has two main goals: maintaining financial stability and controlling inflation while preventing recession. The two goals are closely interlinked, especially in rattled markets. Financial instability can lead to malfunctioning credit and money markets, affecting investment and consumption. Bernake has recently tried to guarantee this financial stability without providing the sense that the Fed would bail out any temporary market correction. This role in stressed times is hard and delicate. Bernanke knows that the way he deals with the recent crisis will have important reputational consequences for the future and will endorse value to his future statements/actions. Language means a lot in central banking. Any quick response in the form of cuts in the Fed fund rate would have confirmed the existence of a “Greenspan put” that Bernanke is not comfortable with. Whereas Bernanke –and others in the Fed- would like to see hard evidence in economic data that justifies quick response in terms of interest rate cuts, they are also aware that this could imply some risks. Professor Fred Mishkin, members of the Board of Governors of the Federal Reserve System, defended this last view in Jackson Hole, pinpointing that the Fed should “react immediately to the house price decline when they see it”. Mishkin, in the Greenspan’s tradition went even further defending easing monetary policy even if there has not been real price declines but just a high probability of such an event.

Two different approaches will confront each other in futures decision at the Federal Open Market Committee. On the one hand the view long held by Greenspan, that defends that even relevant changes in market psychology have to be addressed and not wait for hard data to come. On the other hand, we have the view that Bernanke is delivering. Bernanke sustains that other tools are available –not just cuts in the Fed Funds rate- and should be used, that moral hazard needs also be fought, and that if needed, rate cuts will come. There is just subtle difference between both views, but with very different course of actions.

Source: WSJ