Anatomy of a scare: The Fed chairman's good news sparks a panic

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The chairman of the Federal Reserve, Ben Bernanke, said something last week that seemed quite reasonable -- and the roof fell in on global markets.

He said the economy seemed to be recovering, and that if the trend continued, the Fed would begin to pull back on its stimulus efforts -- keeping interest rates low and buying bonds the market is not absorbing.

The stock market freaked out at this seemingly mild, positive declaration, with the Standard & Poor's 500-stock index falling 2.5 percent last Thursday, its steepest one-day decline since November 2011. As economist John Kenneth Galbraith pointed out throughout his career, the market is perverse.

But New York Times columnist and Nobel economics laureate Paul Krugman thinks Mr. Bernanke misspoke. Mr. Krugman wrote on his blog that "the Fed has been consistently over-optimistic since the crisis began." He says the Fed can help "by conveying the message that it will wait to tighten, that it will let the economy recover and allow inflation to rise before hiking rates."

Mr. Krugman argues the Fed doesn't understand that this is not a conventional recession, but a permanent structural reduction of jobs. Unemployment is high, he says, and good jobs are not being regenerated.

Hence, the market is always volatile. Ironically, Mr. Krugman says, the market understands the fragility of the recovery better than the Fed does

Finally, the voice of conventional wisdom: "While volatility is going to remain high, the market next week will move to a consolidation phase." Thus said Peter Cardillo, chief market economist at Rockwell Global Capital in New York, last week. That's Wall Street-speak for: This, too, will pass.

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