Bernanke put

Following the dotcom crisis after which the then Federal Reserve chairman, Alan Greenspan, slashed the US Federal Funds rate in order to stimulate economic growth and stave off a recession, there has been a widespread belief that the US central bank can always rescue the economy by decreasing interest rates.

Since the current chairman is Ben Bernanke this is now known as the ‘Bernanke Put’ (named after ‘put options’ – derivatives that make money in falling markets). The theory is that if the central bank interest rate falls, other commercial banks should be able to lend more cheaply which in turn encourages their customers, namely companies and consumers, to borrow and spend thus rekindling growth.

The problem is that low interest rates also tend to stimulate price inflation and may encourage previously greedy borrowers to take on even more debt (the so-called ‘moral hazard’) so the central bank’s ‘put’, if exercised, can be a very mixed blessing.

Merryn

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