Posted on 11/06/2002 11:19:59 AM PST by fm1
WASHINGTON (CBS.MW) - The Federal Reserve cut interest rates Wednesday to try to get the economy humming again.
By cutting the federal funds target rate to 1.25 percent, the Fed hopes to boost consumer and investor confidence and pump more money into an anemic economy.
"Greater uncertainty, in part attributable to heightened geo-political risks, is inhibiting spending, production and employment the Fed said.
The vote for such action was unanimous.
The group said the risks in the economy are now balanced.
It was the first rate cut since December. The Federal Open Market Committee had cut rates 11 times in 2001, bringing the fed funds rate from 6.50 percent to 1.75 percent.
The move was expected on Wall Street. Forecasters were nearly unanimous in their belief that the FOMC would ease monetary policy Wednesday.
Financial markets had fully priced in a 25 basis point cut and were hedging their bets that the cut would be an aggressive 50 basis point cut.
The federal funds rate is the interest rate banks charge each other for overnight loans. The Fed targets this rate by buying or selling Treasurys in the open market. To goose the economy, the Fed adds money to the system. To contract the economy, the Fed takes money out. Read more about monetary policy.
The economy officially entered a recession in March 2001 after months of slipping industrial production and falling stock prices.
The FOMC had held its fire since last December. It is likely that the private-sector National Bureau of Economic Research will eventually determine that the recession ended in December or January -- if the economy doesn't dip back into a recession now.
The NBER said Tuesday that the recession "may have come to an end," but would wait to make its decision.
The FOMC has been warning since August that the main risk to the economy is a relapse, signaling its intention to cut rates again if the economy appears to be worsening. Even before the FOMC changed its official risk assessment, the committee had said the most likely outcome was a tepid recovery, with uncertain growth in consumer spending and capital investment remaining weak for months.
At the Sept. 24 meeting, two of the 12 FOMC members -- Gov. Edward Gramlich and Dallas Fed President Robert McTeer -- voted in favor of an immediate rate cut. It was the first time a Fed governor had dissented in seven years.
The Fed's 11 rate cuts pushed down market interest rates. Automakers offered zero-percent financing on many new cars, which drove sales to record levels. Mortgage rates, too, fell to historic lows, keeping the residential construction and real-estate markets booming.
Throughout the recession, consumers maintained a steady pace of spending, an unusual occurrence in a most unusual business cycle. Consumers' incomes never faltered, due to a timely tax rebate and tax cut and to a relatively low unemployment rate even in the depths of the recession.
But now the evidence shows that consumers have become inured to low rates. Auto sales have fallen back. Retail sales have slowed. Consumer confidence has fallen to nine-year lows, as the bear market and war talk take their toll on consumer psyches.
Some worry that rate cuts wouldn't spur consumer demand because consumers are heavily indebted at the same time they are trying to save more to make up for the pathetic performance of their stock portfolios.
Consumer spending has propped up the economy, which has grown 3 percent in the past year. Growth is uneven, however. In the third quarter, spending on cars accounted for more than half of the 3.1 percent growth rate.
The low interest rates never really benefited businesses. The spread between Treasury yields and corporate bond yields widened, as creditors began asking tough questions about inflated balance sheets.
Companies didn't face a full-fledged credit crunch; neither was there much demand for credit to expand businesses. Companies had to work off their inventories first. Without a pickup in demand, companies had no incentive to invest in new buildings or equipment or to hire workers.
Desperation move by the Fed.
We're headed into a deflationary period, just like Japan.
''If we all join hands together and buy a new SUV, everything will be OK,''
Whistling past the graveyard.
Morgan Stanley: Deflation Risk High
THE ECONOMIST: Of debt, deflation and denial
Deflation in a Debt Based Economy
No, not at all like Japan.
The problem with Japan's deflation is that it is slowing down their speed of money.
Deflation itself is a good thing. It means that your Dollar buys more. That's why people go to sales, so that they can get more for their Dollar. That's why some people buy used cars, again because they want their Dollar to buy more. That's deflation. It means that things cost less (like computers and cell phones and long distance).
So long as the speed of money doesn't slow down, deflation is a great thing. Everyone wants to be able to buy more with their money, after all.
But what we have to be careful of is to avoid slowing down the speed of money. So long as people are buying houses and cars and Christmas presents and such, then deflation makes us all richer, but if we start hoarding our money then the economy slows down and we become like Japan.
For now, however, Americans are still spending, so we are nowhere near anything like Japan.
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