Jan. 31 (Bloomberg) -- In addition to all the mundane matters the U.S. Federal Reserve considers at its regular meetings -- economic growth and inflation, credit conditions and confidence -- policy makers had a new, perhaps unstated, agenda item this week: their image.

Image isn't the same thing as credibility, which Ben Bernanke has made a priority in his two years as Fed chairman. When central bankers talk about credibility, they mean the public's confidence in the bank to ensure price stability, to guarantee that a dollar next year buys as much as a dollar today (oops).

That's why the Fed monitors inflation expectations so closely. It's a kind of report card from consumers and investors. (I keep wondering what the Fed would do if inflation expectations were to come ``unhinged'' -- officials' terminology -- at the same time as the economy goes into a tailspin. That would be a good test of principle versus reality.)

Image is something else entirely. Central bankers don't talk about it; economists and journalists don't write about it. In fact, the word is rarely used in conjunction with the monetary authority. But it is front and center now.

If the Fed was unaware of the massive liquidations by Societe Generale SA when it cut rates by 75 basis points last week, and if the two-day rout in overseas stock markets was a direct result of those forced liquidations, then the central bank looks as if it was snookered. (Houston, we have an image problem.)

Driving the Boat

What's more, it reinforces the view that the stock market drives the Fed, not the other way around.

Now, none of this is the Fed's fault. Bank of France Governor Christian Noyer testified to a Senate panel yesterday that he notified the European Central Bank and Fed on Jan. 23, after Societe Generale had finished unwinding 50 billion euros ($74 billion) in unauthorized trades by rogue trader Jerome Kerviel. Noyer said he was complying with Societe Generale Chairman Daniel Bouton's request to keep things under the rug until the bank could unload its positions.

Once the timeline of events became public, there was an uneasy sense that the Fed had been hoodwinked, at least in terms of the timing of its move.

And no wonder. There's a nuanced difference between a rate cut intended to restore confidence and to support the financial system (all of us), and one aimed at bailing out Wall Street (just them). Many folks find them one and the same.

Image Thing

If I were an image consultant, whatever that is, I would have advised the Fed to lower its benchmark rate another 50 basis points at yesterday's meeting, which is exactly what it did. Standing pat would have been an admission of, yes, we were stampeded into giving you 75 basis points when we could have waited until the meeting.

Cutting short-term rates again eight days later gives the impression that the two moves were a designed, if delayed, effort to restore policy to a more appropriate setting.

``The Fed had a bad forecast and had to make up lost ground,'' said Jim Glassman, senior U.S. economist at JPMorgan Chase & Co. ``They woke up to the realization that policy had to be someplace else.''

It should be reassuring to the public, he said, to see the Fed cutting its losses by taking aggressive action.

Bernanke may have been slow to grasp the broad-based impact of the credit crisis enveloping the U.S. economy, but he showed himself to be both flexible and nimble when he did: first, by telling the House Budget Committee on Jan. 17 that the Fed stood ready to take ``substantive additional action'' to support growth; and second, by delivering a combined 125 basis points in interest-rate medicine in a span of eight days.

Fundamentals

Major Asian, European and American stock markets are all posting losses for the year. Many have yet to recoup losses from Jan. 21 and 22, suggesting the problem goes beyond one bank's liquidation of a massive position. It may just be that overseas investors are starting to view the U.S. slowdown as a threat to their own export-driven economies.

The U.S. economy expanded at a 0.6 percent annualized rate in the fourth quarter of last year. Residential investment (housing) plummeted 24 percent, its eighth consecutive quarterly drop and the biggest in more than 25 years. Final domestic demand rose 1.4 percent.

The best news for the economy is the normalization of the yield curve. With the Fed's reduction in its overnight rate to 3 percent, the short rate is finally below the market-determined long-term one. The spread is at its widest since October 2005, which will do wonders for bank profitability.

Get Me Rewrite!

The Fed took a lot of flak for the statement released in conjunction with its Jan. 22 rate cut. It ignored market developments and focused instead on ``weakening economic outlook and downside risks to growth.''

The only problem was that there was no recent economic news to change the outlook and trigger such a large, uncharacteristic inter-meeting cut.

Yesterday, the Fed led off its statement with a reference to the ``considerable stress'' in financial markets and went on to highlight tighter credit conditions and the deterioration in housing and labor markets. ``Downside risks to growth remain,'' the central bank said.

Policy makers have finally caught up with reality. An image consultant could have told them that perception was good enough.

(Caroline Baum, author of ``Just What I Said,'' is a Bloomberg News columnist. The opinions expressed are her own.)

To contact the writer of this column: Caroline Baum in New York at cabaum@bloomberg.net.

Last Updated: January 31, 2008 00:17 EST