Thursday, March 22, 2007

Crash and Bernanke

Financial Times

Published: 20/3/2007 | Last Updated: 20/3/2007 20:45 London Time

"Alan, you're it. Goddammit, it's up to you." On Black Monday 1987, the president of the New York Federal Reserve joined the ranks of those relying on Alan Greenspan during a meltdown. He was not the last. By the time the Fed chairman retired, many believed in the so-called "Greenspan put" – that if markets got really bad the Fed would cut rates and bail investors out.

Today, with nervy markets, is there a Bernanke put? Central banks react to shocks in the real world: the co-ordinated global cut after September 11 is one example. But moral hazard makes underwriting markets a dubious activity. Even so, monetary officials know that unduly tight policy after crashes in the US in the 1930s and Japan in the 1990s may have contributed to economic slumps.

Investors should not be complacent, as the precedents are mixed. The Fed eased after the 7 per cent fall in the stock market on October 13 1989 and cut in 1998 after Russia's default and the Long-Term Capital Management crisis caused bond market jitters. But the liquidity boost in 1987 was aimed at forestalling a payments crisis on Wall Street rather than influencing asset prices. And in 2000, the Fed watched Nasdaq fall by 45 per cent, only signalling an easing in December, when it was more clear that the real economy had slowed.

Now the Fed does not have that much "ammunition". At 2.8 per cent, real rates, defined as the target rate less inflation, are about 50-150 basis points more lax than before the 1989, 1998 and 2000 responses. Whether the Fed now has the inclination to bail out markets is even more debatable. Like Mr Greenspan, Ben Bernanke thinks central banks should not try to burst asset bubbles. Unlike Mr Greenspan, Mr Bernanke also rejected a shoot-from-the-hip approach to market slumps during his academic career. His preferred philosophy of inflation-targeting, with a focus on the degree of spare capacity in the economy, suggests taking action only if market moves clearly signal or threaten a deterioration of the real economy. If the emergency phone from New York rings, Ben may be a little less sympathetic.

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