"In a world of uncertainty," Ben Bernanke said in a speech Friday morning, "informing the public about the central bank's objectives, plans and outlook can affect behavior and macroeconomic outcomes."
Case in point? He also said, "Indeed, intuition suggests that stronger action by the central bank may be warranted to prevent particularly costly outcomes." Following which, the stock market went into freefall. The Dow Jones industrial average dropped 366 points, with the other major indexes in similar disarray.
Let's be fair. Investors have a lot more to worry about right now than the shape of Bernanke's nuance. The woeful quarterly earnings numbers reported by four big banks -- Citigroup, Bank of America, Washington Mutual and Wachovia -- are distressing. The news that two "structured investment funds" are having trouble paying back their debts is also nerve-racking. The continued terrible performance of the housing sector, along with oil prices that briefly broke through $90 a barrel on Friday, has the word "recession" front and foremost. The much ballyhooed plan to pull Wall Street's coals out of the fire by creating a "super-conduit," aka "The Entity," may have backfired, by signaling to financial markets that the credit crunch is much worse than people had begun to hope.
As the central banker in charge, Bernanke certainly has the power to move markets with no more than an infelicitous phrase, but we can't give him all the blame for this one.
Nevertheless, what he said was very interesting and deserves close attention. The speech was ostensibly an appraisal of the contributions to economic theory made by Bill Poole, the soon-to-be-retiring president of the St. Louis branch of the Federal Reserve. Poole's academic work focused on the challenge of conducting appropriate monetary policy in the absence of certainty about the true state of the economy.
To simplify vastly, one school of thought argues that, absent total certainty about what is really going on, the Fed should move slowly, carefully and gradually, surprising no one, and thus minimizing potential shocks or disruption to the economy. Another school of thought says that such actions won't make any real difference, because the public will factor into their expectations of what's going to happen any such gradualist moves, and thus negate their impact. Therefore, the only actions the Fed can take that would make a real difference would be surprising ones.
All very interesting, and seemingly theoretical; every speech by Bernanke has the feel of a brilliant lecturer at an Ivy League school stretching his muscles just for the intellectual fun of it.
But then he concluded by saying that a) the Fed should be ready to take "stronger action" to "prevent particularly costly outcomes" and b) that it is very important to keep the public informed about the central bank's plans.
So was he saying to the world: Get ready -- at any moment I might do something shocking? That's almost what it sounds like. And although one might think that Wall Street would be heartened by this warning -- yippee, another big fat rate cut could be coming! -- the flip side is that if Bernanke is preparing the way for strong action, that means strong action could be necessary in the near future. Which, in turn, could explain why the bloom is suddenly off Wall Street's rose, again.
On the 20th anniversary of Black Monday, no less, to the very day. How spooky is that?