As expected the Fed cut the Fed Funds rate again today. Below is the current statement and the March 18th statement by paragraph, with my commentary interspersed:
4-30: The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.
3-18: The Federal Open Market Committee decided today to lower its target for the federal funds rate 75 basis points to 2-1/4 percent.
We started this round of interest rate cuts back in mid-September at 5.25%. Thus, in a little more than six months, short-term rates have more than been cut in half. It seems likely that this is the last cut for awhile. Monetary policy works with long lag times, and at best we should only be starting to feel the effects of the first interest rate cuts now.
4-30: Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.
3-18: Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.
Not too much difference here, except a change in the tense from 'has weakened further' to 'remains weak.' This implies that rather than heading down, the economy is bumping along the bottom. However, last time around they just mentioned weak consumer spending, but this time they added that business spending has been weak as well.
The first sentence is marginally more hawkish than the equivalent statement six weeks ago; the second statement is marginally more dovish. Net-net it looks like a wash. Note that there was no change in the statement about the stress on the financial markets. Given that the last meeting was right at the time of Bear Stearns (BSC) almost going under -- perhaps the most systemically stressful time in the last half century -- the lack of change in this part of the statement is interesting.
4-30: Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices, and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.
3-18: Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.
They are crossing their fingers and praying that inflation does not get out of hand. The Fed has been looking for energy and commodity prices to stabilize or retreat for a while now, and this has yet to materialize (well, the last two days have seen energy prices retreat a bit). The idea behind looking at 'core' measures of inflation is that food and energy prices are more volatile than overall inflation, but that over time they are similar. That has not been the case at all over the last five years. Perhaps its time to junk the whole idea of 'core inflation.'
4-30: The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.
3-18: Todayâs policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability.
They took out the reference to downside risks to growth remaining. This makes the statement far more hawkish. Clearly they do not want to have to cut again.
This is most likely the last cut for a long time. The argument will soon move to if the Fed should be raising interest rates to tame inflation and help support the dollar. Of course, there are still downside risks to growth, but the upside risks to inflation are becoming more worrisome ('uncertainty about the inflation outlook remains high').
4-30: Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.
3-18: Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred less aggressive action at this meeting.
Most of the time there are no dissents in the Fed policy statements; having two members object is very unusual. Fisher and Plosser both disagreed again, for the second meeting in a row. They are clearly more worried about the inflation situation than the rest of the Fed is.
4-30: In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, and San Francisco.
3-18: In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 2-1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, and San Francisco.
As usual, they brought the discount rate down along with the Fed funds rate.
The Fed is like a doctor faced with a patient with two problems: he has cancer (inflation) but is currently having a heart attack (financial markets seizing up). Even though the heart medicine is known to speed the spreading of tumors, you have to give it to the patient or he will die in the emergency room.
It looks like the heart condition has stabilized, although the patient is still very weak and short of breath. This is the last dose of the heart medicine. Soon the patient is going to have to start chemo, or the cancer will get out of hand. Right now the Fed is hoping for divine intervention (moderating prices for energy and other commodities) to make the tumors go away. Its not likely to happen, and the Fed knows it.
However, if they start the chemo too early, it will cause another heart attack. Look for no change in the Fed Funds rate for the next few meetings and then for the Fed to start cautiously raising the Fed Funds rate in 25 basis point increments.
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