Financial Market Turmoil Forces the Fed’s Hand
The Fed held monetary policy steady at the Aug. 7 meeting of the Federal Open Market Committee (FOMC) and continued to say that inflation poses the biggest risk to the U.S. economy going forward.
The FOMC statement did say that “credit conditions have become tighter for some households and businesses,” but the statement expressed the judgment that economic growth would continue at a moderate pace in coming quarters.
Financial market conditions deteriorated markedly in the wake of the Aug. 7 FOMC meeting, forcing the Fed to inject large amounts of reserves into the banking system just to keep the effective federal funds rate close to the unchanged target rate — 5.25%.
In the midst of this turmoil, the Fed issued a public statement on Aug. 10 saying that the central bank would continue to keep the funds rate on target and reminding the markets of the existence of the discount window that banks could go to for credit (at a 1% penalty rate).
The Fed’s words and actions at this stage of the game prompted many analysts and market participants to charge that the Fed under Chairman Ben Bernanke was “out to lunch” in the midst of an evolving financial market crisis.
Market turmoil increased further in following days, and on Aug. 17 the Fed turned more decisive — announcing a half-point cut in the cost of primary credit at the discount window and amending the balance-of-risk statement that had been issued at the conclusion of the Aug. 7 FOMC meeting.
The revised statement focused on the downside risks to economic growth and dropped the long-standing inflation concern. [return to top]