Fed Cuts Interest Rates by 75 Basis Points

In its sixth interest rate cut in as many months, the US Federal Reserve cut the Fed Funds rate to 2.25%, down 75 basis points from 3.0%. Typically, the Fed drops and raises rates at about a quarter of a percent at a time because it signals a change without being terribly disruptive. Since Friday, US interest rates are down a full percentage and 2% since New Year’s Day, suggesting that the Fed finally understands that in fighting inflation it didn’t pay enough attention to the dangers of recession.

The Fed should have been letting the economy run a little hot, as this journal has argued for year, because of the threat of terrorism and its potential effect on the American economy. As it turns out, that would have been the right policy for the wrong reason, but that is better than the Fed’s approach – the wrong policy based on the wrong reading of the US economy.

The Fed justified its cut in a press release that read in part,

Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.

Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.

Today’s policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability.