The Fed cut rates by an expected .25%, but the stock market expected a .50% rate cut in the Discount Rate. The Fed is rumored to be working to cut that rate more right now due to the plummet of stocks yesterday.
But, should the Fed even be cutting rates right now? Are the rate cuts anything more than bailing out financial markets and trying to appease the markets?
Look at recent history. The main reason we are in this mess is the Fed cut rates to 1%, left them there for a while, and then did not aggressively raise them. This allowed for "credit" to be overly extended and lenders to take on more risky loans.
So, are we to think that things have changed and we, as Americans, will not run out and add more credit, again?
What about inflation? PCE may still be in the "comfort zone", but it is worth noting it ticked higher in the last report. With rates being lowered, inflation is likely to grow freely again.
So, why is the Fed really lowering rates? They continue to mention "inflation risks remain" yet the market acts as if that is not the case. In fact, the markets react more when they don’t get their way, like the .50% cut in the Discount Rate.
It should make you think a little harder about what has changed and what remains the same. Think about it hard and let me know your thoughts.
PeterT
December 12, 2007 at 2:29 pm
Robert, with $3 a gallon gas inflation is a concern, but I think deflation is the bigger worry now. If we go into a recession we drag the rest of the world down with us and it will not be pretty.
Chances are they will go too far and this will set up the next boom cycle. But that’s a ways off yet. Right now the Fed needs to make a statement that they are going to do whatever is necessary to keep the economy liquid.
Robert D. Ashby
December 13, 2007 at 8:38 am
Peter – I agree the Fed will do whatever it takes to keep the economy liquid. It is like the government rushing to save the homeowner from foreclosure. They never get it right and only delay the inevitable.
Economic cycles, including recessions, are healthy. If an economy has grown too fast, a recession may be in order to balance it out. That is part of a “normal” cycle. Screwing with it only delays the process and prolongs the problems. It never truly allows for the “correction” that is needed.
Of course, I am not an economist, but that is the way I have seen it for a long time and looking back at history, still believe it to be true today.