Emergency Rate Cut
I can't say I expected this to happen today. So far so good, stock markets are recovering, at least for the moment, but the 75 basis point cut is aggressive and makes me wonder if there are things the Fed knows that we don't. In that sense, I hope this move calms markets rather than reinforcing their worries. First, the statement from the FOMC:
FOMC Statement: The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3-1/2 percent.
The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.
The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.
Appreciable downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Eric S. Rosengren; and Kevin M. Warsh. Voting against was William Poole, who did not believe that current conditions justified policy action before the regularly scheduled meeting next week. Absent and not voting was Frederic S. Mishkin. In a related action, the Board of Governors approved a 75-basis-point decrease in the discount rate to 4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Chicago and Minneapolis.
Here's Greg Ip of the Wall Street Journal:
Fed Cuts Key Interest Rate As Recession Fears Well Up, by Greg Ip, WSJ: Federal Reserve Chairman Ben Bernanke, putting caution aside, orchestrated a steep cut in interest rates just a week before a scheduled policy meeting in an effort to short-circuit a downward spiral of investor confidence and tightening credit.
The three-quarters of a percentage point cut in the Fed's short-term interest rate target -- to 3.5% -- could help restore confidence to investors and counter the threat of recession. But the reduction risks making the Fed look like it panicked in response to market developments.
The move is unlikely to be the last cut, the Fed indicated. "Appreciable downside risks to growth remain," it said, vowing to "act in a timely manner as needed to address those risks." ...
The immediate market response was positive. The Dow Jones Industrial Average, down as much as 464 points early in the morning, recovered much of those losses by midday. European markets, which were falling steeply, reversed course and closed higher on the Fed's action.
The Fed said it acted because of "weakening of the economic outlook and increasing downside risks to growth. Broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets."
The Fed statement suggested a downshift in its worries about inflation. It said it expects "inflation to moderate in coming quarters" though it will "monitor inflation developments carefully."
The move would be "pointless" if it merely shifted a scheduled rate cut ahead by a week, said former Fed governor Laurence Meyer, now vice-chairman of consultants Macroeconomic Advisers LLC. "Instead, today's move was driven by a desire to get a larger cumulative change in the federal funds rate by the end of the month." He predicted a half-point cut next week. ...
The move was the first rate cut between scheduled meetings of Fed policymakers since the immediate aftermath of the Sept. 11, 2001 terrorist attacks...
The Fed last cut the target for the federal-funds rate, charged on overnight loans between banks, by as much in 1982, when it was lowered a full point. Prior to 1994, however, fed funds rate cuts weren't announced, and the Fed relied on the less-important discount rate, charged on direct Fed loans to banks, to signal its actions. It cut that rate a full percentage point in 1991. ...
The rate cut follows five months of gradualism in which the Fed has seen each of its last three rate cuts rapidly overtaken by events, as the credit crunch and housing collapse deepened. Mr. Bernanke had been balancing those risk against still-high inflation. But he signaled on Jan. 10 that he had shifted his focus principally to supporting growth as employment, retail sales and manufacturing activity all weakened sharply. While some Fed officials mulled the merit of an intermeeting cut then, Mr. Bernanke figured the speech would serve to recalibrate market expectations enough that he could wait until next week's meeting.
That game plan changed Monday in response to a double dose of bad market news: first, that several major bond insurers could lose their triple-A credit ratings, which would shift the risk of default on an additional billions of dollars of debt back onto banks, further constraining their lending; and then, on Monday, the global stock market rout, which cast into doubt the rest of the world's ability to ride out a U.S. recession. ...
And, Brad DeLong points to Rex Nutting:
Fed cuts rates 75 basis points in emergency move - MarketWatch: WASHINGTON (MarketWatch) -- Hoping to halt a market meltdown and prevent a recession, the Federal Reserve lowered its overnight lending rate by three quarters of a percentage point to 3.50% on Tuesday in a rare move between formal meetings.
The 75 basis-point surprise cut came after global financial markets sold off in dramatic fashion on Monday on fears that bad bets in credit markets could spread further and drive the U.S. economy into recession. See full story on London markets.
"The committee took this action in view of a weakening economic outlook and increasing downside risks to growth," the Federal Open Market Committee said in a statement. The Fed also lowered its discount rate by 75 basis points to 4%. It was the largest cut in the federal funds rate since 1982, after the FOMC had driven rates to 20% to kill inflation.
U.S. stocks opened with huge losses. The Dow Jones Industrial Average was down more than 450 points, or more than 3%. Treasurys rallied. "This move is not an instant fix," wrote Ian Shepherdson, chief U.S. economist for High Frequency Economics. "The economy is still staring recession in the face, but at least the Fed now gets it." With the move coming just eight days before the next scheduled meeting, "there can be no doubt that the timing of this morning's move is aimed at supporting global financial markets after yesterday's global equity meltdown," wrote Joshua Shapiro, economist for MFR Inc. Some traders said the Fed's move sniffed of panic. "I think that there's an element of thinking that, if the Fed is so worried that it is cutting rates, then that is feeding into fears that the U.S. economy is in really bad shape," said David Page, a strategist at Investec Securities in London.
After a conference call Monday evening among the 10 voting members of the Federal Open Market Committee, the FOMC released a statement early Tuesday saying downside risks to growth remain. One member of the committee, William Poole, president of the St. Louis Fed, voted against the move. One other, Fed Gov. Frederic Mishkin, was absent. "While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households," the FOMC said. "Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets." "Appreciable downside risks to growth remain," the statement said. "The committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks." The statement barely mentioned inflation, only saying that the FOMC expects inflation to moderate and will monitor inflation carefully...
I teach most of today and can't so much on this, so here's more from: Jim Hamilton, Paul Krugman, Andrew Samwick, WSJ Economics Blog (here and here too), Bloomberg, Financial Times, Felix Salmon, Wilhelm Buiter, and Barry Ritholtz.
Posted by Mark Thoma on Tuesday, January 22, 2008 at 09:51 AM in Economics, Financial System, Monetary Policy |
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