Listen to this article
Just five years on since the last time, the mighty US of A finds itself again at basket-case interest rate levels. On Wednesday, the Federal Reserve slashed the benchmark rate by 50 basis points to just 1 per cent and left the way open for further cuts. It is amazing that just 14 months ago the Federal funds rate was 5.75 per cent. But it should not be a surprise. After the technology bubble burst, rates fell by almost 5 per cent in a year.
Irrespective of whether this latest series of panic cuts helps to buoy markets (Wednesday’s lacklustre response was not encouraging), investors must surely now question the reverence they have previously shown the Fed. Arguing if policy makers are “in front of or behind the curve” is moot. Rate reductions of this magnitude show clearly that chairman Ben Bernanke (and Alan Greenspan before him) have no more clues as to the direction of the economy than Joe Sixpack.
Being reactive, however, does not render the Fed impotent. At the margin, lower rates will help. More important is that the Fed’s other responses to the crisis appear to be working and will probably do more to help aggregate demand than lowering headline interest rates. For example, after it started buying short-term debt from banks and companies on Monday, three-month issuance – which had virtually ceased since Lehman Brothers collapsed – leapt to $67bn the following day.
So what next? Obsessing over the coming months about whether the benchmark rate is heading to zero or not is wasting time. Investors instead should monitor the Fed’s half dozen-odd other initiatives to see if banks are lending to each other – and to the wider economy – again. If credit markets stabilise, a severe recession can be avoided. Attention should then turn to prices. Only if core deflation is avoided will the Fed’s interest rate cuts gain traction.
To e-mail the Lex team confidentially click here
To post public comments click here
Lex is the FT’s agenda-setting column, giving an authoritative view on corporate and financial matters. It is also one of the few parts of FT.com available only to Premium subscribers. This article is provided for free as an example. A Premium subscription gives you unlimited access to all FT content, including all Lex articles and the FT mobile Newsreader.
If you have questions or comments, please e-mail email@example.com or call:
US and Canada: +1 800 628 8088
Asia: +852 2905 5555
UK, Europe & Rest of the world: +44 (0)20 7775 6248
Get alerts on Financials when a new story is published