The US Federal Reserve Board's unscheduled decision to cut its benchmark federal funds rate by a huge 75 basis points on Tuesday morning has been greeted by opinions ranging from relief to derision. Some have welcomed it as a signal that the Fed has finally acknowledged the prospect of a recession and, even if it has acted somewhat later than needed, this should go some distance in stemming the decline. Others have felt that this was "too little, too late", with pointed references to the fact that till quite recently, Fed Chairman Ben Bernanke had been downplaying the seriousness of the situation and had his hand forced when, led by US markets last Friday, markets around the world went into a tailspin on Monday. The prospect of a repeat performance when US markets opened after the long weekend clearly played on the collective mind of the Federal Open Markets Committee (FOMC), where only one member out of nine dissented on the decision. A third opinion is that Mr Bernanke's action may not help avert a recession, which has deep roots in the financial crisis, and instead will repeat the Greenspan mistake of helping to create another asset bubble, which lies at the heart of today's financial crisis. | |
| On the face of it, the action has brought some relief to global investors; Asian markets, including India, have reversed course and, even if they have not recovered the substantial ground lost over the last several days, at least a bottom seems to have been found for now. While US markets started trading on Tuesday sharply down, there was some recovery during the day, which ended with a moderate loss. But is it the Fed's job to salvage bloated asset prices? |
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| This may not be the last of the Fed's interest rate cuts. Observers are virtually unanimous that next week's FOMC meeting will see a reduction of at least another 25 basis points, perhaps even 50. Beyond this point, however, problems may arise. This recession is emerging in a relatively threatening inflationary scenario, particularly from oil prices, which, though they have softened a bit in recent days, are still extremely high by historical standards. Given this, the FOMC may find it difficult to get a majority to vote in favour of rate cuts substantially below the 3 per cent mark, whereas rates had dropped to 1 per cent in the last downturn. In other words, the Fed may not have adequate room for manoeuvre to avert a recession. |
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| Perhaps the strongest signal that Mr Bernanke intended to send with this unscheduled rate cut was to the administration and Congress. He has emphasised the need for extremely quick action if a fiscal stimulus is to have any impact. He has done and will continue to do his bit as far as monetary policy is concerned but he is operating within limits. Therefore, if there are clear signs that Mr Bush's fiscal package will be up and running in short order, both the economy and the markets may gain adequate reassurances from the Fed's actions. If not, then 2008 is going to be a long and difficult year. |
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