Federal Reserve & Interest Rates

Vice chairman of the Federal Reserve Board of Governors, Donald L. Kohn, gave a speech Friday on the economic outlook. He reflected on recent actions made by the FOMC and explained the move.

“…it seemed that a decrease of that size could well be necessary to promote moderate growth. We had been holding the federal funds rate at 5-1/4 percent, well above the expected rate of inflation, in part to compensate for what had been very narrow yield spreads and readily available credit. We did not know how quickly markets would recover, the extent to which credit terms and standards would be tightened, or precisely how households and businesses would respond to recent or forthcoming financial developments. But, pending further evidence, a 50 basis point easing was not an unreasonable first approximation of what might be required to keep the economy on a sustainable growth path.”

Some critics were quick to say that the high market performance and the new positive employment data make the move look unnecessary in hind sight. According to Kohn, it was a reasonable and safe move, and the goal was to have a healthy affect on the economy for the long term, not so much for a quick fix.

Kohn continued to describe current conditions. Several markets have shown signs of improvement. It will take time for the new policies to ease the economy overall. Kohn expects housing markets to remain depressed for at least several months. Credit may continue to be more difficult and more expensive to obtain for some.

He also noted, “The FOMC emphasized the considerable uncertainty in the outlook. As I noted earlier, we do not know how financial markets will evolve, and we do not know how households and businesses will respond to financial developments. Naturally, these types of uncertainties are greatest when markets are behaving abnormally.”

As for the falling value of the dollar, new German economic data suggests that there may be a slip in the strength of the Euro. A lower Euro value is good for the U.S. Only time will tell how the United States economy will end up. It is too early to tell how recent events will impact the overall future economy. What we do know now is that we should be prepared for some difficult times in the months ahead. Overconfidence in the market could become a problem.

Hopefully, we will pull through the months ahead, and the worst is almost over.