Nobody Likes the “R-Word”

28 Aug

Mark Thoma makes some sense:

We don’t need a recession. If the Fed determines an interest rate cut is needed to keep the economy moving toward full employment, then it shouldn’t hesitate to implement the policy because it believes it would send the wrong signal to financial market participants. I hope we don’t get so caught up in our zeal to make sure people learn the right lessons from all of this that we allow “bad investments in the past” to bring about “the unemployment of good workers in the present.”

I encourage you to read the whole thing.  There are two things to consider when arguing that the Fed can’t cut rates because of “moral hazard.” First, to what extent are market corrections (like the bubbles before them) driven by psychological cues? (i.e. Aren’t overly cautious investors likely to assume too much risk and over-correct on the way down as they did on the way up?). And second, haven’t the worst of the lenders been driven out of the financial market already?  (Larry Summers made this last point on This Week while cautioning that the crisis isn’t over yet).

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