"As we know, " said Rumsfeld, "there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns . . .the ones we don't know we don't know."

Rumsfeld may not have been speaking about economics but, as this week's events from the US indicate, his grasp of the pivotal role of uncertainty in human behaviour was as sharp as his political cunning.

When on 17 August the US Federal Reserve unexpectedly lowered the rate it charges on direct loans to banks and hinted at a possible interest rate cut in September, it was more than reacting to the sharp changes in "nancial markets on the days preceding the decision.

First, the surprise move in monetary policy is perhaps the only sure way of achieving short-term non-inflationary impact on an economy stuck in excess capacity short-run equilibrium. What is more important, such policy has strong impact on the traded sectors . . . a point well illustrated in several studies, including the one released by the European Central Bank this week that "nds that traded sectors are almost three times more sensitive to unexpected liquidity supply changes than their domestic counterparts.

These are salient policy objectives. In recent months, slowing of the US economy has fed through into slower job creation and personal income, affecting productivity growth. This signals that US companies have successfully displaced most of the driftwood employees, leaving more productive workers in place. At the same time, tighter credit and uncertainty about mortgage markets started to weigh in on consumer con"dence and lower spending on durable goods.

The net result? Despite increasing by 0.4% in July, US leading economic indicators, compiled by the Conference Board, remained flat in the first half of 2007. Six of the 10 indicators advanced last month but three fell (building permits, capitalequipment orders and interest-rate spread), while factory hours were unchanged. All of this suggests there are serious clouds gathering on the horizon, as the declining indicators are linked to future business activity and productive capacity.

This is precisely the scenario that Bernanke was talking about in his 2003 lecture at the London School of Economics. According to his research, looking at the data from 1989 to 2002, "as expected, changes in monetary policy that were anticipated by the market had small and statistically unimportant effects on stock prices, presumably because these changes had already been priced into stocks".

Bernanke also stated that he believes unannounced changes in monetary policy should be carried out by the Fed outside the usual schedule of planned interest rate decisions in order to deliver stronger impact on the levels of real economic activity.

In other words, it is the known unknowns about Fed actions that drive markets responses to monetary policy, while the knowns of economic fundamentals underpin the need for change itself.

This need for change is based on two forces. The first is the general slowdown in US private capital investment, mentioned earlier. The second is the mushrooming trade de"cit.

A cut in the prime rate together with the short-term inter-bank credit rate will, in theory, help drive dollar down against the main currencies as demand for US government assets is abated by smaller interest rate differentials vis-a-vis US trading partners . . . the EU and Asian economies. The alternative corrective path to the US trade deficit would involve serious de"ation of a magnitude that exceeds that in Japan.

Bernanke, facing the choice of the two evils, is clearly opting to steer the US into the lesser one . . . improving US exports' competitiveness while reducing the attractiveness of imports and internationally-traded domestic debt via further dollar devaluation.

Henry Molloy of Heinz Associates, San Francisco, believes that "the Fed move is in the right direction, because it will go some way in correcting for US trade deficit through, hopefully, reducing the value of the dollar. It will go even further in terms of allowing for refinancing of sub-prime and prime mortgages that are to mature in the next 12-18 months. For Europe, this is bad news, but for the US, this is a classic Taylor Rule exercise to support the economy at the low point of the business cycle".

This observation is supported by the facts that Washington's Macroeconomic Advisers LLC have for weeks been urging the Fed to put more emphasis on slowing growth than on inflation. The Fed did exactly that last Friday, when it issued the statement talking about "the downside risks to growth [that] have increased appreciably".

In other words, being well-timed, largely unexpected and, hopefully, signalling a return to a more accommodative Fed policy in the near future, last week's cut in US short-term rates is a welcome sign for the real side of the US economy.

Which brings us to the last part of Rumsfeld's proposition. Despite the visible pick-up in the stock markets, commercial paper markets around the world continued to lose ground this week. The Fed has been forced to inject ever-rising doses of liquidity into the credit markets . . . some $13bn of new interbank lending on Wednesday and Thursday alone . . . in addition to accepting mortgagebacked securities as a backing for inter-bank loans, saddling the Central Bank with potentially high levels of bad private debts.

At this stage, no one really knows whether this monetary sand-bagging will stem the mounting losses.

Should it fail, the only resort left to the Fed will be to lower interest rates.

Such a move will exert renewed downward pressure on interest rates in Europe, Japan and Asia.

Either way, the next few months will be about accelerating volatility in the markets, driven by the unknown unknowns tied into mortgage and other financial markets behaviour, large banks ability to rebalance books and Central Bankers nerves.

And this is hardly reassuring for an average investor expected to stay put through the storm.