Is Wall Street Now Conducting Monetary Policy?
From Larry Kudlow's very interesting column today "Anatomy of a Fabulous Fed Flip-Flop":
On the afternoon of Aug. 7, the Federal Reserve chair was an inflation hawk -- according to the unchanged FOMC policy statement -- fearful of adding liquidity to the markets. By day's end on Aug. 9, however, he was leading the liquidity charge, initiating a process that would help unlock the credit seize-up that started in late-July.
Using the Freedom of Information Act, Ken Thomas, researcher and lecturer at the University of Pennsylvania's Wharton school, was able to get Bernanke's calendar of phone calls and meetings at the time the flip-flop occurred.
Over the next few weeks, Bernanke participated in no fewer than 35 separate conference calls with fellow Fed operatives -- a complete departure from his earlier no-conference-call style. And he got the liquidity ball rolling. As we now know, the Fed started pouring liquidity into the system on Aug. 9.
Exhibit A: See the chart above (click to enlarge) showing the significant drop in effective Fed Funds rate on August 9 to 4.68%, at a time the official target rate was 5.25%. During the entire month of August the effective Fed Funds rate was 5.02%, almost a quarter point below the official target. Simply put, the Fed implemented an unannounced "secret" rate cut to 5% in August, under pressure from Wall Street.
But is this a good outcome? Kudlow seems to think so, and says that "the academic Bernanke became a hands-on market participant through his contacts with Rubin, Paulson, the hedgies and others. He reached out to savvy financial-market players, who put him in touch with the real world."
Doesn't this call into question the concept of "central bank independence?" Most economists consider it desirable to have central bank decisions insulated from political pressure from politicians seeking short-term political goals, so that the central bank can do what is best for the economy in the long run. But shouldn't the central bank also be insulated from pressure from hedge fund managers and investment bankers on Wall Street, which is apparently exactly what happened in August? Wouldn't an official inflation target insulate the Fed from Wall Street pressure?