Rate Cut Well Runs Dry: Will It Force The Fed To Back Off?

Find below the full text of the latest FOMC statement on the recent rate cuts:

From the Federal Reserve:

“The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.

Since the Committee’s last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined.  Financial markets remain quite strained and credit conditions tight.  Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably.  In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.  In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level.  As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.  The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.  Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.  The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco.  The Board also established interest rates on required and excess reserve balances of 1/4 percent”

As I’ve been saying since the beginning the current crisis isn’t a function of high interest rates, it’s function of poor risk management, bad investments, poor regulation and derivatives abuse(just to name a few), and at the end of the day lower interest rates have little effect on those things.  In the end we’ll see the same pattern from last fall: a rate cut provides a temporary boost to the markets, followed by the markets falling right back down as more and more real problems come to light.

In my view the best thing about the most recent rate cut is that there isn’t much room to cut rates further, which may force people to focus on the actual systemic problems faced by the economy as opposed to believing it can be magically fixed via rate cuts.

At the end of the day a central bank can’t save a country from an economic slow down by printing money, currency deflation, etc, especially when cheap money caused that particular country’s economic crisis in the first place. Not to mention the fact that history shown these tactics to be rather disastrous at best.

The other major issue here is that aside from the rate cuts the Fed is undertaking various measures (along with the Treasury) to singlehandedly prop up the economy, and is undoubtedly taking on far more than it can chew. The long-term effects on the U.S. economy (especially when you consider our debt issues) caused by taking on more debt, effectively printing money, deflating our currency, etc, could easily be more grave than anything we’re facing now.

This idea of “we’ll do whatever we have to do now because we can think of a way to fix it later” is the very thinking that got us into this mess, the fact that it’s seen as a cure to our current woes is positively farcical. At some point (for the sake of our future) the Fed and the Treasury need to back off, and focus more on mitigating the impact of the slowdown on individuals rather than doing anything they can to keep the recession from running its course.

At some point you have to just let things happen and accept that recessions are a sometimes necessary (and unfortunate) part of the economic cycle. Instead of thinking short-term we have to think about whether or not we’re preparing ourselves to have a stable future, as opposed to the current practice of mortgaging it for the present.

The optimistic side of me hopes that this rate cut is the thing that forces us to start working on our systemic issues as opposed to trying to fix the problem via injecting faux confidence, whilst the cynical side of me figures that the government will only think of a new round of shenanigans now that the rate cut well has run dry.

Let’s hope that my cynical side is wrong.

Source:

The Federal Reserve: “FOMC Statement” — December 16, 2008.

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn’t be viewed as financial or investment advice.

Subscribe by RSS Subscribe by Email