The Federal Reserve, especially its current chairman, has received quite a bit of criticism for its performance during the last several months in dealing with the economic turmoil in the markets. The primary complaint is that the Fed is behind the curve in dealing with the economic slowdown. The other major criticism is that the Fed is sending out conflicting signals, which are causing dangerous confusion in the market.
With regard to the first point regarding Fed actions, it remains to be seen if the Fed is behind the curve. Alan Greenspan once said that the Fed cannot prevent bubbles but can help to cushion the economic fallout. This may be true.
Although there were recessions under Dr. Greenspan's watch, they were in general milder than those under previous Fed chairmen. Dr. Bernanke may be in a similar situation. Only time will tell if he is as effective as Dr. Greenspan was. We must all remember that Wall Street has its own set reasons for desiring easier monetary policy by the Fed which may be linked to its own self-interest.
However, the second criticism does have some justification. There has been a more open atmosphere at the Fed under the new chairman, but this has led to confusing and contradictory statements from Fed members. Many people on Wall Street and Main Street are uncertain as to the Fed's intentions.
This is a dangerous situation. One can argue that the Greenspan Put was too lenient and that people assumed too much risk because they felt that the Fed would use monetary policy to bail them out of bad investment decisions. However, everyone knew that Greenspan was in control of the situation and would act decisively.
Although the Bernanke Put may be different, market participants must be confident in the Fed's actions for it to be effective. If people do not believe that the Fed is serious about reducing rates, it lessens the effectiveness of the rate cuts themselves. This undermines the Fed's actions and may require additional cuts to prove its point.
Perception affects reality. Dr. Greenspan understood this clearly and used it to his advantage. Although Dr. Bernanke's policies may be different, he must utilize this tool as well. In a crisis situation such as the 1987 crash, confidence in the Fed's actions is crucial to achieving a successful outcome.
If the economy continues to deteriorate, Dr. Bernanke needs to be extremely clear about the actions that the Fed is taking to deal with the situation. Otherwise, he may create undue market volatility instead of lessening it.
Doug Roberts is the Founder and Chief Investment Strategist for FollowtheFed.com, an independent research firm focusing on investment strategies using the Federal Reserve's impact on the stock prices. He previously held executive positions at Morgan Stanley Group and Sanford C. Bernstein & Co.
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