This afternoon the Fed lowered the overnight fed funds target by one-quarter of a percent to 4.50%. As a result, the prime lending rate will drop to 7.50%. In a statement accompanying the rate decision, the members of the Federal Open Market Committee (FOMC) were careful to be as even-handed as possible. On the one hand, they pointed out several risks to renewed inflation including solid economic growth in the third quarter and rising prices for oil and other commodities. On the other hand, the FOMC noted, “The pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction.” (Correction” is FedSpeak for “crisis”.) The bottom line is that “the upside risks to inflation roughly balance the downside risks to growth.”
The Fed continues to display the lack of leadership that has characterized it since the summer. Basically, the FOMC had little choice today but to lower the fed funds target. Fed funds futures had a nearly 100% probability of a cut, and crossing up the markets could have caused who knows how much damage. The Fed is supposed to be proactive; instead we have a Fed reacting to today’s economic news. The first estimate of third quarter Gross Domestic Product was just released this morning! If the Governors of the Fed have good reason to believe that the economic expansion “will likely slow,” their mandate is to get out in front of the slowdown by lowering interest rates aggressively. If their analysis convinces them that the expansion remains solid, their mandate is to restrain credit conditions by keeping interest rates stable or even increasing them.
Instead, “the Committee will continue to asses the effects of financial and other developments on economic prospects.” Just like everyone else.