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  • Home>Research & Insights>Market and Economy Quickview>The Fed Gambles With Its Credibility

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    The Fed Gambles With Its Credibility

    There comes a time when the best strategy is to do nothing.

    Kent Grealish, 09/28/2011

    Being of a certain age, I can remember when Chubby Checker first sang "The Twist" and how cool that dance seemed at the time.  Now, of course, the Twist is rarely seen and then only at certain weddings and high school dances alongside the Macarena, the Chicken Dance, and the Electric Slide.  It has become an anachronism.

    Unfortunately, another fad of the '60s, the belief that government through the actions of the Federal Reserve Board can "fine tune the economy," never seems to fall out of fashion. So it is ironic that Chairman Bernanke's recent stimulus attempt is being called Operation Twist--an homage to the last time the Fed employed this scheme in 1961. 

    The Fed has been trying to stimulate the economy with lower interest rates since the beginning of the financial crisis. But the economy is not responding, so here we go again with yet another attempt to force rates downward. The belief that all we need for economic recovery is for rates to go just a little bit lower is, as they say, the triumph of hope over experience.  It also calls to mind a line from another Chubby Checker hit record (Limbo Rock): How low can you go?

    The greatest tool the Fed possesses is the belief that it is more powerful than is actually the case. For while it is true that the Fed can influence interest rates (and the economy), a common misconception is the Fed can actually control interest rates. Jimmy Carter and his Fed Chairman, G. William Miller, discovered this to their sorrow. Once confidence in the Fed is lost, it takes a huge effort for it to be earned back (which goes a long way toward explaining why Jimmy Carter was forced to appoint Paul Volker as chairman).

    I am sympathetic to the fact that the Fed has run out of ammunition and has been reduced to throwing rocks instead of shooting bullets. Nevertheless, there comes a time when the best strategy is to do nothing and appear callous rather than pursue a hopeless course of action and be thought irrelevant. 


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