The Federal Reserve just announced a bigger-than-expected rate cut. And with that, it has used up its short-term rate cutting ammunition for the first time in history.
The sad part is that even though the Fed has been cutting rates -- from 5.25% last summer to today -- the economy has not responded.
The specifics of today's rate cut are historic. The Fed lowered its target for the overnight federal funds rate to a range of between 0% and 0.25% -- a record low. Even though it's a historic low, today's announcement was ratifying the market reality -- demand for interbank loans has been so low that the actual Fed funds rate has been at 0.1% in the last several days.
The problem is that even though we are in a financial meltdown caused by too much borrowing, the Fed has decided that the best way to solve the problem is to get people to borrow more. But they don't want to lend the money that the Fed is giving away. Meanwhile, prices dropped in November by 1.7% -- more than ever in recorded history -- due largely to a rapid decline in energy prices.
If the Fed is so eager to get money out there, it would be better to go around the banks and give the money directly to individuals and businesses. Strangely, the Fed trusts the banks that got us into this mess by borrowing way too much to buy dodgy assets more than the average American citizen or business executive.
As I've posted, the next step is quantitative easing -- but with the economy tanking despite the Fed's best efforts, I don't see how this would help.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter
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Reader Comments (Page 1 of 1)
12-16-2008 @ 3:52PM
Iridium said...
I wouldn't take the 1.7% drop in comsumer prices as anything but a good thing.
It reflects the drop in energy prices more than anything else. The drop needed to happen and energy is still priced far above what the real market dictates. If we get a massive drop during the next reading then Wall Streeters can go panic.
What did people think oil could remain at $150 and we would be fine. Oh yeah glass tower traders did think so. They wanted to push it to $200 and watch thier wallets fatten in front of thier eyes.
12-16-2008 @ 4:40PM
Uhohchongo said...
"The problem is that even though we are in a financial meltdown caused by too much borrowing, the Fed has decided that the best way to solve the problem is to get people to borrow more."
Great point.
I personally think the only way to get through this crisis, is by injecting our economy with $2-3 trillion and worry about raising taxes significantly(for everyone) in a couple years.
Then again, unless everyone feels some kind of humility or pain during this crisis, old habits will be renewed.
12-17-2008 @ 8:54AM
Ed said...
How the U. S. Congress stole $700,000,000,000.00 from the taxpayers of the United States * No requirements * No tracking * Money given to poorly managed and corrupt banks and investment firms
How the money was spent by the banks and investment firms * Executive bonuses * Executive payraises * Parties * Purchase of other companies * Rat-holed somewhere (skimmed off)
The motivation for congress? See history of contributions to every member of congress from Wall Street firms (e.g., Obama from Goldman Sachs- over $ 690,000.00- see opensecrets.org).