There is no need to go through a recession just to make the 'organizations that were investing poorly' pay. The market won't discriminate to that degree (ie, good investments that have nothing to do with housing and have wonderful balance sheets like Apple will also go down).
If you're going to use medical analogies, I'd say that avoiding a rate cut to punish the 'bad' companies is like committing suicide to alleviate an upset stomach....
Anyways, the problems weren't caused by lower rates alone - banks weren't very good at evaluating the risk profile of the people they were loaning money to. And repackaging mortgages to sell them to the 'bigger fool' gave them little incentive to be more vigilant - in fact, it rewarded aggressive lending practices .
I think lenders are now more aware of the problems with this line of thought, which is why they are so reticent to lend now.
Hopefully the Fed will cut again at their next meeting.
Explain how hyperinflation will occur when what is typically a person's most valuable asset (home) decreases in price. Explain how hyperinflation will occur if we're in for a recession and the associated job losses.
Lowering rates does not sacrifice long term growth. Rates were drastically lowered in 91 and 82 (83?) as well, and that didn't exactly negatively impact long term growth.
I'm serious, and I'd appreciate something concrete to help me understand why my viewpoint is incorrect.
If you have a strong dollar, you can lower rates. But the dollar is at an all-time low, so then to have a 75bps drop hit it, the result is essentially pushing it towards hyperinflation.
That's the theory anyway. There's been alot of criticism on it, but macroeconomists in reserve banks around the world tend to subscribe to this theory when using interest rates to control growth and inflation.
The relationship between interest rates and the dollar is via the interest rate parity condition (http://en.wikipedia.org/wiki/Interest_rate_parity), which is a feature of open markets (to take into account arbitrage opportunities). Lowering the value of the dollar doesn't cause inflation directly. I suppose it does so indirectly by stimulating exports and raising output growth, which leads to lower unemployment and so on.
Lowering interest rates will likely increase inflation, but hyperinflation is a bit rich. Current US inflation is 4%, which is high, but a long way from hyperinflation (see zimbabwe - 1000%+).
> Actually in classical macro theory, lower interest rates (which amounts to the Fed increasing the money supply) ... hence price inflation.
If the money supply is increased (more dollar bills are printed), you'll need more to pay for the same thing: and that is directly price inflation. You can ignore the expected effects in the middle. (In fact, there's no direct correlation to cheaper credit and greater investment.)
4% is stated core inflation. The true inflation number is much higher, but it's hard to know because there's a lot of effort put into diminishing it, for obvious reasons. Sure we're not in hyperinflation yet, but the idea is that it could get there quickly. While it seems impossible from the comfort of growing up in the second half of the 20th century, America is in much more trouble than it realizes.
I guess that given the huge drops in housing values, combined with the layoffs that will (and have) occurred in the banking and housing industries, I am more worried about deflation than inflation. $100 oil and a lower dollar don't matter as much as banks going under and people walking away from their houses.
Deflation is also bad. Bernanke thinks that the effects of the Great Depression could have been mitigated if monetary inflation would have offset the deflation that was occurring. And I think that what he's doing here. Unfortunately, he's about to find out why that doesn't work.
If you want your people to spend money and buoy the economy, perhaps instead of making it easy to borrow what they don't have you should try NOT TAKING SO DAMN MUCH from them in the first place. Listen carefully: Money you take from the people and spend in Iraq is gone, mmkayy?
Constantly trying to balance on the razors edge of economic collapse and then issuing even MORE credit (and measly tax rebates) when you've gone too far can't possibly be the optimal implementation.
Ok, sorry, rant over.
It was merely to illustrate that such a point exists. After a certain absolute percent, raising taxes will REDUCE tax receipts and wreck your economy at the same time. I'm certain were all the way down the back side of that curve near the "wreck your economy" shoulder. Yes, even though our absolute tax is lower than some smaller countries whos economies have evolved to operate at a greatly reduced rate.
It does also miss many of the 'hidden' taxes we still pay. For example, everyone in this state has to get a silly sticker on their car every year so the mechanic can pretend to look at the breaks and then try to charge you $35 for a $5 light bulb. The sticker costs $25 but I've never made it thru in less than an hour. The price of the silly sticker AND the wasted hour is a tax. There's one $25 fee and at least one wasted hour for every car in the state. This kind of thing is particularly noxious because they could have just had a little courage and added the $25 to the regular car tax, but instead wasted 100's of thousands of man hours a year on what is almost always a fictitious "inspection".
You should see what it takes to be able to build a shed in the back yard for your lawnmower...
Inflation is usually a tax as well. If a government needs money, can't borrow it, and its not politically expedient to raise taxes again, it can simply print up some money and steal a little from each of the other dollars that people already have.
There's also start of and end of life taxes that have to be amortized over the years of the life of a person. If you make a little money or live in a place that sees real estate rise, this is non-trivial.
Even the tax code ITSELF is a tax. The ever increasing burden of compliance is nothing but dead weight for individuals and businesses.
Finally, there's a stack of extra tax and extra man-hour-wasting hassle headed your way if you have the audacity to try to work for yourself and not simply settle into a nice job in an industry with lobbyists and get your w2 like everyone else. This is probably the one that interests the readers of this forum the most.
One slightly other off subject comment on the article. The government using taxation as a vehicle to transfer wealth from the "rich" to the "poor" is a recipe for economic disaster. Ever dollar "robin hooded" is a dollar sucked directly and completely from economic growth. Its a near perfect disincentive for innovators to innovate.
Sorry to slasdot/troll the issue but I am passionate about this particular area! The point of all this is, there are better ways to fix the economy than an interest rate cut!
One reason is that, on the whole, a wide variety of things are getting better over time. Including our wealth -- we are getting richer, despite all our taxes.
Another issue is that if we are on the verge, then, for example, the UK is already too far gone. But that doesn't really seem to be the case. Civilization is very resilient.
The USA is still a major player in the world economy but it is no longer the center. That said this downturn may bust us Americans down a notch or two on the world stage, perhaps even enough that we have to make some serious lifestyle changes. So the question emerges: If I can't drive my hummer down to Mickey-D's and supersize that please... is it a disaster or what?
The Forest Service used to do the same thing with forest fires. They were considered an anathema and each fire was put out the second it started until the fuel (dry brush, etc.) would accumulate to the point that a single match would give you an unprecedented, unnatural, monstrous firestorm.
We've become so afraid of an economic downturn that rates are slashed at the first chance, etc. At some point, it won't work anymore -- there's just too much fuel waiting to burn.
Put on your asbestos, kids. This one's going to get hot.
So the Fed is doing what (little) it can to encourage the market in those assets to function again.
Ultimately, though, it cannot force people to take on risks they don't want, so even a large rate cut like this one may not make a difference in this climate.
But if you agree with the FED, it should be easier now to get money for your startup... even though 1 million dollars will value about 1000 euros.
The reckless mortgage boom and the ensuing crisis was caused when the Fed cut rates to avoid recession and made borrowing so easy. Now to fix the mess caused by lowering interest rates, they're trying to lower interest rates?
If you're bleeding from your wrists because you slashed your wrist with a knife, you don't slash your arm higher up to stop the bleeding from the wrists. Well true, it does stop you from bleeding from the wrists but now you're bleeding from the upper arm! Of course, you can stop the bleeding there by slitting your biceps. Pretty soon you're going to have to cut off your arm to "stop" the bleeding.
How about they just let there be a recession so the organizations that were investing poorly lose money and go out of business while the investors who were smart and focussed stay in the game?