Is the Fed cutting rates too slowly?

In fact, pressure from Wall Street to cut rates may be having the opposite effect, according to Robert McTeer, who retired in 2005 as president of the Dallas Fed, one of 12 regional banks that make up the Federal Reserve system.

“The market keeps dictating to the Fed what the Fed ought to be doing – and the Fed doesn’t like that,” said McTeer. “The Fed likes to feel likes it's using its own judgment and it doesn’t like to be boxed in. That’s probably why (Bernanke’s) not cutting rates outside the regular meeting cycle. He may think they need to be cut today, but it would be just one more example of the Fed being jerked around by the market.”

Bernanke’s defenders also note that until recently, a policy of aggressive rate cuts wasn’t necessarily a no-brainer. Even as the credit markets were in turmoil last August, the economy was turning in solid 3.9 percent annual growth for the third quarter and the job market was relatively strong.

It’s also not clear that cutting rates and pushing more money into the financial system would have prevented the credit crunch that is weighing on the economy. Money has gotten tighter mainly because lenders and investors are worried about parting with their money — at any price.

“People are afraid they won’t be repaid when they lend money," said McTeer. “If you worried about being repaid, a quarter-point, half-point or even a whole point difference in the interest rate is meaningless to you. “

Avoiding recessions — and keeping employment levels high — is only one of the Fed’s twin mandates. The other is maintaining stable prices, a goal that is foremost in the minds of anyone — including Bernanke — who lived through the prolonged and painful inflation of the 1970s. Though inflation is relatively tame, rising food and energy prices have begun to push so-called "core inflation" above the Fed’s target range of 1 to 2 percent.

“The Fed’s basic job is prevent a resurgence in inflation, and while you still have a few people out there saying that inflation is not a problem – that’s just not true,” said Alfred Broaddus, former president of the Richmond Fed. “The Fed's reluctance up until now to really drop the rate, say a full point in one meeting, is because of that constraint.”

While the Fed can soften the impact of recessions, it can’t always prevent them from happening. Some Fed watchers say recessions are an important part of the business cycle; by periodically flushing out speculation and unproductive businesses, the economy builds a firm base to promote stronger future growth.

“The public should not expect the Fed to be fine-tuning the economy with monetary policy and avoiding all recessions and ending the business cycle,” said Broaddus.

For now, the Fed is acknowledging it could use some help. Bernanke told the budget committee Thursday that an emergency stimulus package could help — but only if Congress gets it right. Such a package has to come soon enough give the economy a quick boost without adding to the budget deficit; otherwise it could do more harm than good, Bernanke said.

But the success of any fiscal stimulus package from Congress rests heavily on whether the Fed has gotten it right with its monetary policy setting interest rates, according to McTeer.

“The impact of fiscal policy depends on monetary policy being correct,” he said. “But if monetary policy is correct you probably don’t need fiscal policy.”

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