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Question of the Day: Will the Fed’s Actions Work?

By JLP | January 31, 2008

I’m confused.

I was under the impression that the Fed did not want to lower interest rates due to inflation fears. I guess those fears have taken a back seat to recession fears as the Fed has lowered rates by 1.25% within a week’s time.

QUESTION:

Do you think these interest rates cuts will prevent a recession?

I don’t see how they can work in the long run especially with the housing market the way it is. I think we have backed ourselves into a corner and the only way out is to let the markets do their thing. It’s not gonna be fun, but I think it is the only way.

Now, what are your thoughts?

UPDATE: I reworded my question because it was originally kind of vague.

Topics: Question of the Day | 17 Comments »


17 Responses to “Question of the Day: Will the Fed’s Actions Work?”

  1. Dan Says:
    January 31st, 2008 at 11:05 am

    I think that the United States has been overconsuming at unsustainable levels, both publicly and privately, for many years. Our overconsumption has been financed by debt bought mainly by foreign investors. At some point, this imbalance has to adjust back to equilibrium. With this in mind, fiscal and monetary policy designed to stimulate consumption seem merely to prolong the problem.

    More articulate commentary along these lines from the Financial Times:

    http://www.ft.com/cms/s/0/28b464a2-cf50-11dc-854a-0000779fd2ac.html

  2. Jeremy Says:
    January 31st, 2008 at 11:09 am

    I agree. These types of band-aids can slow the bleeding, but they won’t be able to correct the years of uncontrolled growth that caused a lot of these issues to begin with. You simply can’t maintain a market or economy that continuously grows at a rapid pace. It has to go through the natural cycles in order to flush out the bad and bring the systems back into equilibrium so that a new period of expansion can begin. Without these periods of reduced growth, you just create a bubble which is bound to collapse. This type of collapse is far more harmful to the economy and the consumers than if things didn’t get out of hand in the first place.

    Sure, I’d love it if the stock market never went down and if real estate would always appreciate in value, but that isn’t realistic. And when people get stuck on the idea that this is how it should work, they do foolish things with their money. This is for individuals, businesses, and money managers alike. You see a few good years of solid growth so you jump in with both feet blinded by greed and the possibility to cash in, only to find out that everyone else was doing the same thing and growth it created has nothing to sustain itself, therefore creating a more painful collapse.

    This doesn’t imply that the Fed’s actions won’t help, because maintaining suitable interest rates is a key aspect of monetary policy. But to think that these changes will have a significant long-term effect, especially with inflation concerns still very real, you can’t artificially keep the economy afloat forever.

  3. Emily Says:
    January 31st, 2008 at 11:11 am

    I agree with the comment above. I think the whole thing is ridiculous. America needs to tighten their belts (both the government and individuals). I fear for our future and basically think that the people running our country is either dumb, don’t care about long term consequences, or are completely sadistic and want to watch us suffer years from now. I am just angry about the state of our government and country. I think that almost all Americans have no clue what kind of financial state we are in. I talk to my friends and they say, “The government will take care of everything.” Do not get me started on the economic stimulus package!

  4. trip Says:
    January 31st, 2008 at 11:13 am

    Containing inflation should be goal number one. I’ll take a recession over runaway inflation any day, and the Fed should too. Something is amiss.

  5. Greg Says:
    January 31st, 2008 at 11:29 am

    The Fed’s actions illustrate the fear that persists among the powers that be about the future of our economy. If they are willing to take such drastic measures it should be sending a strong signal to all Americans that we are teetering on the brink of some unpleasant economic times. The best thing to do right now is conserve your resources and prepare for a bumpy ride, which could include a rise in unemployment, wage deflation and price inflation — in other words a reduced standard of living. This scenario also damages American prestige around the world at a time when we face many threats from rising competition. We could be entering a period of weakness while the rest of the world (China, India, Brazil, Venezuela, Russia) is growing stronger.

  6. plonkee Says:
    January 31st, 2008 at 1:28 pm

    I don’t think that large interest rates signal a strong economy. I’m not looking to increase my investment in the USA for a while yet.

  7. Russ Says:
    January 31st, 2008 at 1:35 pm

    I agree with the comments here. The interest rate cuts will be far more harmful in the long run. This is one of the main reasons for the decline in the dollar. Interest rate cuts just creates more money, which reduces the value of the money in circulation, hence inflation. The risk in the market will come out somewhere, it cannot be contained forever.

    This just goes to show how removed the U.S. is from a real free market economy. It is as much quasi-government controlled as it is free.

    Thats my $.02 worth anyway!

  8. sam Says:
    January 31st, 2008 at 3:56 pm

    Do you think these interest rates cuts will work?

    Work at what? Forestalling a recession? Fixing the subprime mortgage mess? Reducing inflation? Helping politicians get reelected?

    Frankly, I dunno what it will do other than making it cheaper to borrow. Whether that makes the overall economy better or worse is beyond my prognosticating power. Maybe it will keep some companies going and prevent layoffs or bankruptcies that would otherwise occur. Or maybe it will cause people and companies to overspend their incomes and make things worse. Only time will tell.

    As for me, I’m stocking up on canned goods and ammo.

    Just kidding!

  9. db Says:
    January 31st, 2008 at 5:00 pm

    I’m doubtful.

    One thing I worry about is that there really isn’t much room to lower further. We’re at 3%? On marketwatch.com they are already speculating on another .5%-1.0% cut in Feb.

    All of this is supposedly to stabilize the stock market, however while the outright plunge of the first couple of weeks seems to be taking a break, there is still significant volatility to the downside, and the markets aren’t reacting with the love the pundits thought they would.

    I think the planners are out of touch with reality — this is a crisis brought on by overconsumption, cheap credit and underregulation of certain industries like the mortgage industry.

    Just like the “economic stimulus” package, now they are trying to solve the problem by encouraging more consumption, only at a different level.

    It just seems to me that this is wrong, both short-term and long-term. As for me, no time like the present to save.

  10. Matt Says:
    January 31st, 2008 at 6:37 pm

    I think that if anything this will push the economy into further trouble. The problem was caused in the housing market with people doing nothing more than speculating and taking risks that they shouldn’t have. In all seriousness why would fiddling with the Fed rate do anything? I think this was a snap decision that will have a longer term impact.

  11. LiveWell Says:
    January 31st, 2008 at 8:26 pm

    I’m going to buck the trend and say that yes I think these rate cuts will prevent a recession. Lower interest rates may mean all the difference to some of the people on the edge of foreclosure. Others who are paying off their mortgages will be able to refinance at a lower rate which means they’ll have more disposable income to either spend or save. And then there’s a third group who has been waiting for a housing decline before they jump in. Those people’s patience has now been rewarded by both lower prices, an attractive interest rate and more attentive mortgage lenders.

    As far as the stock market goes, we weren’t seeing outrageous P/E ratios at the peak in Oct. 2007. Now with the decline they’re even more reasonable. I think there has been a lot of hype about recession, it scared people but the Fed has stepped in with a meaningful rate cut that will help people financially if not psychologically.

  12. Dave Says:
    January 31st, 2008 at 9:00 pm

    This is not an Economic Stimulus Bill. Plenty of pundits are suggesting that there are better ways to stimulate the economy. This is a “Get Me Reelected” Bill.

  13. Jeremy Says:
    January 31st, 2008 at 11:32 pm

    “Lower interest rates may mean all the difference to some of the people on the edge of foreclosure. Others who are paying off their mortgages will be able to refinance at a lower rate which means they’ll have more disposable income to either spend or save.”

    This isn’t entirely true. The rate cuts only deal with short-term interest rates. Sure, someone with an outrageous ARM that is resetting may be able to refinance at a better rate, but this will do almost nothing to traditional mortgage rates across the board.

    In fact, if inflation continues to become a concern, we may actually see mortgage rates go up in the coming months or year. So this band-aid that is being used to try to stimulate the stock market, economy, or whatever you want to call it will be just that. People who are unable to make mortgage payments won’t be helped by this at all. If they are extremely lucky and in a very poor mortgage to begin with, they might be able to shave a little bit off by refinancing, but that assumes reasonably good credit as well.

  14. db Says:
    January 31st, 2008 at 11:32 pm

    Well (thankfully) we can’t reelect Bush. Don’t even think of the other one and election…

    I do think, though, that this is an attempt at being remembered fondly for something.

  15. JLP Says:
    January 31st, 2008 at 11:46 pm

    db,

    I’m pretty sure this mess would have happened no matter WHO was in office. With the internet bubble bursting and 911, Bush didn’t have a lot going for him to begin with.

  16. Steve Says:
    February 2nd, 2008 at 4:29 am

    The problem with mortages right now (subprime or not) is that the average person has a dropping house price, so there is nothing to back any funds to borrow, no matter what the rate. The rate can be 1%, but it doesn’t matter if the person trying to borrow has 130% CLTV on their home because of a price drop. Most people are upside down on their mortgage, which poses a problem only to people who can’t afford the payment. If you owe more money on your house than it is worth, but you can afford the payments anyway, you can wait out the housing crunch, and in 10 years it won’t matter anyway.

    What is hurting things right now is that the people who were driving the spending the most were the ones who could least afford to do so. They got overextended, and now they can’t afford the payments, and the refinance they thought they could do on the 5/1 ARM is not available, no matter what their credit score. You can’t borrow 20 dollars against a 15 dollar widget, no matter what your credit history or income.

    These same people now *need* that line of credit to pay bills and the backing of those funds aren’t there. The lowering of the rate doesn’t do any good for these people. And even if you aren’t overextended, the banks are tightening the screws to lower risk of future forclosure, but the curren’t overextenders are going to be part of this forclosure scene for a few years yet before everything normalizes.

    The nice thing is that for those of us who didn’t get caught in the hoopla, money has become cheaper to use as leverage, and the savvy investor should be able to take full advantage.

  17. db Says:
    February 2nd, 2008 at 11:36 pm

    JLP:

    Perhaps, and perhaps not. Perhaps it wouldn’t be quite as serious as it is — perhaps if we had an administration that spent a modicum of effort (seriously) on domestic issues. I think the current one has been neglectful there.

    Also, the dot-com bust was already history, but there is no guarantee that 9-11 would have happened under a different administration.

    But I didn’t mean to drag politics into this, rather I was responding to the mention that this was a “get me reelected” ploy. We can’t reelect Bush. But I still think a major motivator for him is to try and raise his 30-odd% approval rating out of the gutter and try to be remembered for something (anything) positive.

    Not that it’ll work in this household.

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