Will a Fed rate cut be enough to stave off a stock market collapse?
*The Economist, January 22, 2008
“THE Federal Reserve slashed its benchmark interest rate by three-quarters of a percentage point to 3.5% on Tuesday January 22nd. The decision came at an unscheduled policy meeting—the next planned one was due on January 29th and 30th, when it was widely expected to reduce rates by half a percentage point. With global stockmarkets in freefall, the Fed instead decided that a bigger cut was needed—and sooner. A week may be a long time in politics, but waiting eight days to cut rates would, it seems, have been an intolerable stretch for financial markets.
The deepening gloom about the economy may well warrant such an aggressive response. But the timing is puzzling. There is more than a whiff of panic about slashing rates little more than week before a scheduled meeting. The Fed statement issued with the decision rationalises the cut as a response to “downside risks to growth”—the phrase is repeated twice in six short paragraphs—and cites recent gloomy data on housing and jobs. Yet the economic news has not grown any worse in the past few days and, given the time needed before monetary policy affects spending, the added urgency seems odd.
What has shifted for the worse is financial-market sentiment. It is hard not to conclude that the Fed has acted to shore up markets, which have switched to panic mode alarmingly quickly over the past week. The Fed noted—it could hardly fail to do so—that ‘financial market conditions have continued to deteriorate.’ But if concerns of further stockmarket damage was its main motivation the cut did little to prevent a big sell-off on Wall Street.”
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