In order to stop inflation, the Fed is supposed to increase interest rates and decrease the money suppy. So why are they lowering interest rates if inflation is looming
Why cut rates? Inflation?
The FED is lowering rates to avoid or reduce the chances of a total financial collapse of the US economy much like 1929.
Inflation is being caused due to foreign buying of commodities such as the grains and oil. Mostly from China and India. Inflation is not being caused by the increasing of capital goods prices or due to a robust US economy which would normally cause inflation.
Commodity prices in general are causing the inflation. The FED took 4 years to figure this out.
The FED is finally more concerned about the US economy collapsing and bank failures than they are about inflation right now.
The FED is willing to deal with inflation for the time being. As the economy improves (real estate and credit markets), the FED will increase rates more rapidly in the future.
Note: Inflation is good. It means there is growth. No inflation means no growth. The USA is in a Stagflation environment = Recession + Inflation.
Why cut rates? Inflation?
The plummeting housing prices are pushing the economy toward DE-flation, not IN-flation.
The lowered interest rates are to help prevent more bank failures, such as Bear Stearns, whose stock went from $150 to $2 in 12 months.
Why cut rates? Inflation?
Rates are raised to either damp inflation or cut to stimulate the wider economy.
The federal reserve balances these two risks, and the risk of an economic downturn at the moment far outweighs the risk of inflation.
Remember that an economic downturn will have a severe damping on inflation anyways, so if the economic news is bad, then future inflation pressures will be somewhat moderated, increasing the liklihood and ability of the Fed to cut rates.
Why cut rates? Inflation?
well, right now the economy is bad enough that Fed took that as a priority before inflation.
Why cut rates? Inflation?
There%26#039;s also the issue of the availability of credit. That is, the ability of people and businesses to borrow money.
Large financial institutions have swung from one extreme to another. Not long ago they were lending people money to buy houses who really didn%26#039;t qualify for those loans -- on the theory that house values would continue to climb, and people would pay their mortgages above all other debt. (Given a choice, would you rather lose your Visa card -- or live in the street?)
Now they%26#039;re afraid to lend anybody any money, and the ones sitting on billions of dollars of subprime mortgages are in a severe cash flow situation.
So the Fed is lowering interest rates to encourage people to borrow, to keep money flowing through the economy.
You are correct in that there are high inflationary forces still at work on the economy -- the price of oil keeps going up, which will force up the price of goods and services.
Lower interest rates in the U.S. are bad for the value of the US dollar, which means we%26#039;ll be paying more money for exports.
So, is it wise to lower interest rates? I don%26#039;t know. Bernanke is between a rock and a hard place.
It%26#039;s probably healthiest in the long run for bad debt to be squeezed out of the economy ASAP -- but that inflicts a lot of pain. Since the Great Depression, we%26#039;ve been unwilling to endure it.
How many families do you want to see on the cable new shows evicted from their homes, partly because of their own bad judgment but also because of the bad judgment of the company that approved their mortgage?
(I continue to hold a grudge against General Motors Acceptance Corporation because they approved a car loan I didn%26#039;t think my wife and I would qualify for. I didn%26#039;t want the car - my wife did, and rather than have a big fight with her, I thought I%26#039;d just let the loan be denied. It should have been, but wasn%26#039;t!)
How much are you willing to see the unemployment rate rise?
How many businesses go under?
And this is an election year, so we want to keep the economy flowing.
Why cut rates? Inflation?
Slowing economy, inflation concerns, softening job numbers, declines in consumer spending, continued concerns about the mortgage markets, weakening dollar. The Fed Statement specifically said %26quot;%26quot;The outlook for economic activity has weakened further. Financial markets remain under considerable stress, and the tightening of the credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters,%26quot; the Fed said in a statement accompanying the decision.%26quot; The market was actually expecting a 1% cut, so its less than expected, the Fed will never raise rates when the economy is struggling, even when inflation is high, specifically because of what happened in the 1970s where rates increased but the economy tanked and unemployment rates soared. The Fed has to walk a tight rope. The current Fed Rate is 2.5% which is still much higher than the low point in 2002. The fed waited a bit to long to start cutting rates, and now they are trying to overcompensate. Personally I think its too little too late, and now they have to appease the markets and keep inflation in check. Keep in mind that Adjusted CPI is 2.3% which in a historical context is relatively low. Unadjusted its 4%, still not particularly high, historically inflation averages about 3-3.5% looking back to 1914. Inflation in the mid 70s and early 80s was close to 13%.
