Second Fed Rate Cut: Not Too Little, But Maybe Too Late to Ward Off a Recession

While the second Fed rate cut in a month–announced Wednesday afternoon–wasn’t a huge surprise to the financial community, the thought process behind it was: The Fed’s scared, and that doesn’t offer much comfort to those worried about an impending recession.

The new cut brought the benchmark Federal funds rate down by half a point to 3 percent and followed an emergency reduction eight days ago, which lowered the benchmark interest rate
by three-quarters of a percentage point.

Wall Street had widely expected the reduction–stocks ended the day Tuesday "sharply higher" because of anticipation that the Fed would offer an interest-rate cut of at least half a percentage point today, according to Forbes.com–but still reacted strongly to the new. Stocks rose within minutes of the announcement.

Why? Well, the economy stinks–according to news this week from Washington that included the lowest new home sales rate since 1995 in December and a ridiculously slow growth rate (which plummeted from a 4.9 percent pace to an annual rate of 0.6 percent in the fourth quarter), thanks in part to a 24 percent drop in homebuilding that was responsible for pulling 1.2 percentage points off growth.

That big building decline was the eighth consecutive one for residential construction–and the biggest drop since 1981, which is, coincidentally, the last decade in which the Fed went on a rate-cutting spree. All summer, the Fed maintained that inflation was much more of a concern than housing for the overall economy–now, it’s singing a different tune.

The Fed said today it "expects inflation to moderate in coming quarters," and although it will continue to monitor "inflation developments," cited the "deepening of the housing contraction" as a major concern.

Pick up any newspaper or read an article online and it’s clear much of the financial industry agrees. It’s never a good sign when reports are comparing current data to data from the Great Depression; and the Fed hasn’t cut rates this fast since I had a perm.

The government clearly has had a reality check in the last month: They’re proposing all kinds of ways to revive our sagging economy. The House approved President Bush’s stimulus plan today–if the Senate follows suit, cash rebates will soon be making their way to our mailboxes and, Bush hopes, will boost consumer spending. The Fed said its back-to-back January cuts were designed to promote steady growth in the coming months.

But the true effect of both measures remains to be seen. Was the Fed a little late to the game in recognizing the harmful effect the housing decline was having on the economy? And will offering two rate cuts in a month really safeguard the U.S. economy against the recession and speed up growth?

Post your opinion and let us know what you think about the Fed’s move.