Sunday, September 2, 2007

Some Perspective on Bernanke’s Speech

The excerpts below are from a WSJ article giving some perspective on Bernanke’s speech in Wyoming.

The Federal Reserve won't bail investors out of their bad decisions but will act if recent market turmoil threatens economic growth, Chairman Ben Bernanke said Friday.

Mr. Bernanke's much-anticipated speech solidified investor expectations the Fed will cut its target for the federal-funds rate -- charged on overnight loans between banks -- from 5.25% when policy makers meet Sept. 18. Markets see some probability the rate will drop to 4.75% but several economists said a drop to 5% is more likely, accompanied by a statement suggesting more cuts could come. Those expectations helped boost stocks.

The speech was Mr. Bernanke's first since credit-market turmoil erupted shortly after the Fed's latest policy meeting, on Aug. 7. He sought to delineate the Fed's separate responsibilities for keeping the financial system operating smoothly and maintaining economic growth. At the same time, he made clear that financial instability also affects growth and thus the Fed's interest-rate deliberations.

"It is not the responsibility of the Federal Reserve, nor would it be appropriate, to protect lenders and investors from the consequences of their financial decisions," Mr. Bernanke told the audience of academics, central bankers and Wall Street economists from around the world gathered at the Kansas City Fed's annual symposium in Jackson Hole, Wyo. "But 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." . . . .

. . . . Elaborating Friday, Mr. Bernanke said financial markets reflect not just a concern about the eventual economic impact of a weaker housing market, but also a rise in uncertainty and risk aversion generally. Risk premiums -- the additional return lenders and investors require for dicey investments -- had been "exceptionally low" so some increase "is probably...healthy." But he said heightened risk aversion, when mixed with "heightened concerns about credit risks and uncertainty about how to evaluate those risks," created "significant market stress."

While not explicitly signaling the Fed's plans, the speech did make clear, according to some economists, that Mr. Bernanke is intimately aware of what has gone on in markets and the implications. That alone, some say, can help confidence. "There was a time...when a lot of Wall Streeters were referring to Bernanke as an academic who had no clue what was going on out in the real world," said Stephen Stanley of RBS Greenwich Capital Markets. "He has done his best to disabuse market participants of that impression over the last few weeks without giving in to their pleas for immediate help."

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