The Federal Open Market Committee, the Fed's policy making arm, failed to take decisive action against a slowing economy on December 19th. The Fed held the line on interest rates by keeping the fed funds rate at 6.5%.

To be sure, Greenspan & Co. did announce a shift in monetary focus from inflation-watch to recession-watch. Yet the Fed's decision to stay the course is a huge gamble with the economy decelerating far faster than most forecasters anticipated even a few months ago. What's more, with the leading inflation indicators tame and price competition picking up as the economy slows, why not ease?

Indeed, if the only question troubling the monetary watchdogs was the state of the economy and inflation the central bank might have acted differently. Consumer confidence is faltering, and management is hunkering down for tough times. The more than 50% decline in the Nasdaq since its March high is troubling. Looking at the economy in isolation, the Fed should have taken out an insurance policy against a severe downturn next year. Then what stayed the Fed's hand? The Fed seems haunted by the brokerage house refrain that the central bank won't let the stock market decline too far or too fast. Yet economists, including Alan Greenspan, the nation's chief economist, strongly believe that letting investors suffer losses is a valuable reminder that taking on too much risk can be costly. From the Fed's perspective, the danger in easing now is giving credence to the Wall Street mantra that the stock market has become so central to the new economy's performance that the Fed will limit any decline. Economists call this classic central banker dilemma "moral hazard."

A reminder that stocks are risky is no bad thing. Let's just hope the price tag for the lesson isn't too steep.

 


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