Now I’m never going to be known as a Fed watcher (and I’m very glad of that), but I happen to have Ben Bernanke’s testimony before the Joint Economic Committee on the TV at the moment, and I here’s my on-the-spot interpretation of what he’s saying:
Unless things get really, seriously horrific on the housing front, the Fed isn’t going to do much about it. It’s still too worried about inflation. As Bernanke put it:
Although core inflation seems likely to moderate gradually over time, the risks to this forecast are to the upside.
Meanwhile, the risks to his forecast of continuing “moderate” economic growth go both ways:
To the downside, the correction in the housing market could turn out to be more severe than we currently expect, perhaps exacerbated by problems in the subprime sector. Moreover, we could yet see greater spillover from the weakness in housing to employment and consumer spending than has occurred thus far. The possibility that the recent weakness in business investment will persist is an additional downside risk. To the upside, consumer spending–which has proved quite resilient despite the housing downturn and increases in energy prices–might continue to grow at a brisk pace, stimulating a more-rapid economic expansion than we currently anticipate.
Now this doesn’t mean the Fed won’t cut short-term interest rates from the current 5.25% sometime this year. But I don’t see anything like 2001 (when the Fed funds rate went from 6.5% at the beginning of the year to 1.75% at the end) happening again. I don’t think anybody else does, either. But I haven’t heard a lot of Wall Street economists point out that, if the housing bust does throw the economy into recession, Bernanke’s Fed is unlikely–because of inflation fears–to engineer a quick bailout.