The Federal Reserve announced today it was lowering its target for the fed funds rate 75 basis points, from its previous value of 4.25% to a new value of 3.5%.
The Fed’s statement itself does not read like such a big deal:
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.
But actions speak louder than words, and this is a big action. This appears to be the first time in the 25 years for which we have a decent series for the Fed’s target that the Fed has implemented such a large cut in a single move. Another unusual aspect of the measure is that it came a week before the Fed’s regularly scheduled FOMC meeting.
The closest precedent for today’s action would be April 18, 2001, when the Fed announced a 50-basis-point cut 4 weeks in advance of its regularly scheduled meeting. The cause on that occasion was intermeeting evidence of deteriorating economic conditions. We now know in hindsight that the economy was already one month into recession at the time of that April 2001 decision.
The Fed’s action appeared to be prompted by turmoil in international equity markets. While Americans were on holiday Monday and still asleep Tuesday morning, London’s FTSE 100 index fell 5.5% and Japan’s Nikkei 225 lost 8.7%. Indian stocks fell so quickly that the Bombay Stock Exchange halted trading.
Felix Salmon doesn’t like the idea of the Fed responding to equity prices:
There’s one reason and one reason only that the Fed took this move, and it’s the plunge in global stock markets on Monday, along with indications that the US markets were set to follow suit.
Now the Fed is charged with keeping employment high and inflation low; it’s not charged with protecting the capital of investors in the stock market. So this action smells a bit like panic to me, and it might also have prevented the kind of stomach-lurching selling which could conceivably have marked a market bottom. I have to say I don’t like it.
I doubt very much that anyone on the FOMC has much interest in protecting the investments of stock market participants. Instead, I suspect that the Fed is using equity prices just as I and many other economic analysts do, namely, as a useful aggregator of private and public information about near-term prospects for economic growth. All the recent indicators have suggested a significant deterioration of real economic activity over the last two months. I take the global stock market sell-off as one more confirmation of that assessment, and new information about the global scope of the problems we face.
Mook, a commenter at Calculated Risk, offered this colorful analogy:
The Bernanke Fed is like a 19-year-old army trainee who’s never fired a shot in anger and is suddenly dropped behind enemy lines with an Uzi.
He’s shaking in panic but gripping his trusty gun tight, secure in his ability to destroy whatever foe he comes across.
The problem is, he fires off a half-clip in panic every time the wind rustles the trees.
Pretty soon he’s going to stumble right into an enemy squadron and pull the trigger, only to hear the fateful ‘click-click’ that indicates he’s out of ammo.
And anyone who’s watched a war movie knows what will happen then.
I agree with Mook on this much– a 75-basis-point cut can not prevent a recession, if one is indeed already under way, any more than the 50-basis-point cut in April 2001 prevented that downturn. But, while many members of the public may believe in the Fed’s omnipotence, I doubt that members of the FOMC share that illusion. I expect that Bernanke instead simply intends to do what he can to mitigate the damage.
My bottom line? I believe the FOMC cast its vote today with those who declare that a recession has already begun.