Federal Reserve & Interest Rates

At the latest Federal Open Market Committee meeting, last Wednesday, there was another rate cut.  The target for the federal funds rate was reduced by 25 basis points to 4 ½ percent.

This action is supposed to “forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.”

According to the press release, the FOMC predicts that “after this action, the upside risks to inflation roughly balance the downside risks to growth.”  It is believed that this additional rate cut action will help to curtail the effects of inflation on the economy.  There has been some upward pressure on inflation due to energy and commodity prices, but core inflation readings for this year have improved modestly.

With all the concern for inflation, the continued weakening of the dollar, and the sub-prime lender’s market hanging on by a thread, there is just no telling which way the economy is going to go.  When the rates were cut in September, it was implied that we were on the verge of a recession.  The markets improved for a while, but everything else seemed to stay nearly the same. Should we think that the rate cut is a sign that the economy is more on a downward slant than the Fed cares to mention?

The Fed, consumers, investors and economists alike are unsure about how the economy is going to perform.  Things could go either way at this point.  It seems that with all of the inflation concerns that further rate cuts won’t be happening for a while.  Once again, only time will tell how the economy will do.

In addition to the reduction in the Federal funds rate, the FOMC injected a dramatic $41 billion into the banking system one day later.  This is the highest infusion of liquidity since September of 2001.  Other added funds were inserted into the financial system at amounts of $38 billion in August and September.  This liquidity assistance is primarily to help keep lenders in business.  Without the additional cash flow, there could be a major freeze on credit in the nation.  The system runs on a complicated system of debt, so a credit crunch would be very bad news.  How much more money will it take to keep a credit crunch from happening?

Economic uncertainty will most likely continue to be the repeated term that describes the outlook for the United States economy.  Hopefully, we will pull through.