FOMC Cuts the Funds/Discount Rates: Growth the Goal

Going for Growth - or at least some positive momentum is the goal. Today, the FOMC cut the funds rate by 75 basis points. Our view is that the economy is currently working through the recession. Yet inflation remains above the Fed’s perceived inflation range - note the dissents! Credit issues remain a critical drag on the economic outlook.

Credit and Growth: Lower Funds Rate to Help on Both Fronts

Our belief is that the easier funds rate is intended to offset the credit drag on the economy and thereby limit the depth and cost of the recession. The evolving credit crunch has limited the availability of credit to both households and business. As a result, we expect that real GDP growth will begin to recover in the second half of this year but remain below trend growth for the rest of this year (top graph).

"Financial Markets Remain Under Considerable Stress"

Credit restraint has spread into many areas of the economy, particularly commercial construction and, to a somewhat lesser degree, business fixed investment as well as state & local government spending.

"Inflation Has Been Elevated"

As evidenced by the personal consumption price deflator graph in the middle, we see that the inflation data remain above the ceiling of the Fed’s target range.

"While the Committee Expects Inflation to Moderate, Uncertainty About the Inflation Outlook Has Increased."

Two dissents to the 75 basis point ease were registered by Presidents Fisher and Plosser who have been noted as hawks on the inflation outlook.

The statement also notes that "a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization." This is a "projected" future for prices and so there is a real concern about the path for inflation and, therefore, there is a limit to how aggressive the Fed will be going forward on rate cuts given the strong language in the accompanying text on inflation and the two dissenters.

Fed and FOMC are Different Institutions

How can the Fed take such aggressive actions over the weekend and yet ease only 75 basis points while the market discounted 100 basis points? The Federal Reserve Board, operating out of D.C., focuses more on the credit/economy concerns and intervened in the markets to deal with a very short-term problem.

Meanwhile, the FOMC draws upon the regional presidents where there is greater weight given to the long-term consequences on inflation of current policy. Here is where you get the dissents based upon inflation uncertainties. Two institutions with different time horizons and relative weights applied to a dual mandate.

Wachovia Corporation
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