Official: Economy shouldn't be punished to teach speculators a lesson

WASHINGTON -- Federal Reserve policymakers should consider the impact of turbulent financial markets on the economy's health when weighing interest rate decisions, a Fed official said Friday.

"It makes no sense to let the economy suffer from continuing declines in stock prices for the purpose of 'teaching stock market speculators a lesson,"' William Poole, president of the Federal Reserve Bank of St. Louis, said in a speech to the Cato Institute.

Poole is a voting member of the Federal Open Market Committee, the group that includes Fed chairman Ben Bernanke. It's the group that sets interest rate policy in the United States.

His comments come on the heels of signals from the Fed's top two officials -- Bernanke and vice chairman Donald Kohn -- that a third rate cut may be needed to help the economy survive the intensifying problems in the housing and credit markets.

In a speech Thursday night, Bernanke warned that the problems could chill consumer spending, the lifeblood of economic activity. Bernanke said Fed policymakers will need to be "exceptionally alert and flexible" to deal with the situation. One day earlier, Kohn said policymakers must be "nimble."

Those remarks were viewed as increasing the likelihood that the Fed would slice a key interest rate when it meets next on Dec. 11. The Fed has cut rates twice -- in September and October -- to prevent housing, credit and financial problems from pushing the economy into a recession. At the October meeting, Fed officials indicated there may not be any need to lower rates again. Since then, however, the financial markets' problems have flared up again.

Against this backdrop, a growing number of analysts think the Fed will lower its key rate by one-quarter percentage point to 4.25 percent at the December meeting.

Poole indicated that he didn't buy the argument that the Fed's decision to lower rates created a "moral hazard." Some think the Fed's action could encourage investors -- namely those involved in the risky subprime mortgage market that lends to those with spotty credit -- to make bad decisions all over again.

"In the present situation, many investors in subprime paper will take heavy losses and there is no monetary policy that could avoid those losses," Poole said. The Fed's policy objective "is not to prevent losses but to restore normal market processes," he said.

The free flow of credit is necessary for the smooth functioning of financial markets and the economy.

"The Fed does not have the desire or tools to prevent widespread losses in a particular sector but should not sit by while a financial upset becomes a financial calamity affecting the entire economy," Poole said.