Fed cuts rates to 4.75%

I don’t have time to say much, but I will say that the Fed’s decision to cut rates 50 basis points was silly. They are pretty much telling the market that they will bail them out when the shit hits the fan from taking on overly risky investments. Although this decision may forestall a recession in the US, how many future recessions will be the result of the relatively new Fed governor Ben Bernanke showing that he will follow the whim of the asset market.

People are comparing this situation to 2000/2001 when Alan Greenspan cut rate significantly to stop a recession. If this was even true it would be an indictment of today’s decision, as in some ways the ease with which rates were cut in 2000/2001 lead to the asset bubble we are now facing.

However, todays decision is even worse than the 2000/2001 decision, as inflationary pressures are HIGHLY elevated. A good central bank should first and foremost control inflationary pressures. However, it seems that many central banks are starting to forget their primary goal.

4 replies
  1. Kimble
    Kimble says:

    The rate cut came on the back of the PPI dropping 1+% in August and imports dropped 0.3%-ish. I think it was this good news that allowed the Fed to cut rates.

    CPI is out tomorrow, so that will be interesting.

  2. Matt Nolan
    Matt Nolan says:

    I agree that the PPI measure has eased, and CPI eased today as well (2.0%pa). However, the fall in CPI is the result of easing pressure from the housing market. Price pressure from a weakening exchange rate and rising world commodity prices are still problematic.

    Most of the time I would want the fed to look through tradeable inflation. However, inflation expectation in the US are still fairly high. A drop in the exchange rate and rising food and oil prices will further inflate peoples inflation expectations, which will lead to more resilience in the inflation rate in the future.

    Someone at my work brought up a good point against what I said though. The fed had effectively cut rates 25 basis points in August (http://tvhe.wordpress.com/2007/09/14/has-the-fed-cut-rates-without-telling-anyone/) without telling anyone. As a result, a 25 basis point cut would be equivalent to no change in policy. So in effect, this 50 point cut was really only a 25 point cut.

    It will be interesting to see how the American economy goes during the remainder of the year.

  3. Kimble
    Kimble says:

    I dont think that the drop in the interest rate will affect the US housing market. The funding which fuelled that surge has all but dried up, people now view the extra risk as expensive at any price.

  4. Matt Nolan
    Matt Nolan says:

    I don’t think it will influence the housing market much either. However, I do think that cutting the cash rate as much as they did will weaken their exchange rate (if only by reducing the level of risk faced by hedge funds) causing an increase in tradable inflation. Sustained strong tradable inflation will cement in higher inflation expectations.

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