Fed Cuts Key Interest Rate to 1%
The Federal Open Market Committee held a regularly scheduled meeting Tuesday and Wednesday. At the end of it, the FOMC voted to cut the Fed Funds rate 50 basis points to 1.0%. This is worrisome because the Fed is about out of room to cut. There are other ways for the Fed to boost the economy, but it is close to losing its most powerful weapon. Rates can’t drop below zero.
Many have maintained that the current credit crisis stemmed from the Fed keeping rates at 1% too long back in 2003-2004. This is incorrect. Excessive risk taking and inadequate regulation (and quite possibly illegal activity on Wall Street) are responsible. If anything, the Fed’s misguided rate increases thereafter to fight inflation aggravated the situation. This journal argued that inflation was not as much a worry as deflation and recession, in particular after a major terrorist attack. The only thing missed was the terrorist attack, for which one is grateful.
Deflation is a serious threat. Commodity prices (especially oil) are on the way down. Consumers are pinching pennies until Mr. Lincoln’s eyes are popping. Foreclosures are up. Job creation is not happening. And the Fed really can’t go much further with interest rates. Messrs. Greenspan and Bernanke have helped dig a hole. The issue now is whether the Fed will have any clue as to how to stop digging.
One weapon that may help is “quantitative easing,” or as the Economist defines it, “expanding its [the Fed's] balance sheet through the purchase of either government bonds or increased loans to the private sector.” The British periodical notes that the Fed has already started doing this, doubling its balance sheet to $1.8 trillion – and it says the Fed could go further.
It also says, and this small journal couldn’t agree more, that the Fed can not win this fight without allies. Reflationary fiscal policy has the capacity to get money flowing through the system again. That means either tax cuts or spending programs, and quite possibly both. This will, of course, heighten the national debt. That is a more long-term worry. Right now, the country (and the world) has to put out the fire rather than think about fixing the hole in the roof.
© Copyright 2008 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.
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