Weak central bank parenting

Last week we outlined our parenting analogy for central banks. We focused on differences in approaches to the credit crisis by the Fed, Bank of England, and the ECB. This week we found that all central banks are behaving the same. Parenting is loose with little discipline of the market. Of course, there are consequences with "tough love" central banking, but it seems like these monetary authorities are unwilling to administer tight controls.

The Fed FOMC lowered rates by 50 basis points for both the Fed funds and discount rate. (I was in the camp for 25 bps on the Fed funds and 50 on the discount rate which was a more nuanced signal. This was based not on my preferences but the fact that a number of Fed officials were giving comments that were more hawkish.) The operative wording was that the Fed was acting to preempt a slowdown. Along with Fed, the Bank of England has moved away from its tough talk comments of just a few weeks ago to an announcement that they will be providing funds to help banks. So much for the tough parent. The ECB has already supported banks with added funds. It is hard to hold the line when all of the other monetary parents are lenient.

The reaction was as expected. Stocks went up, led by the financial sector. Bonds on the long-end sold off and the dollar declined. Prices of commodities tied to the business cycle climbed.

Of course, the hawks cannot have it both ways if the central banks took a hard-line position and we headed towards a recession. The economic data is turning down and some cut would have been necessary in 2007, but delaying the cut or making it marginal would have clarified the message that banks need to discipline themselves.