Fed Move Has Economists Worried About Inflation

In a rare and unexpected move, the Federal Reserve cut its benchmark interest rate by 0.75% early yesterday, in response to worldwide selling sprees that sent international stock markets plummeting on Monday.Many economists are worried that aggressive interest rate cuts, which they predict will continue, could threaten America’s long-term economic stability by weakening the dollar and creating runaway inflation.Although the move was meant to prevent a worldwide panic from spreading to American markets — which were closed on Monday due to Martin Luther King Jr. Day — traders sent stocks sharply down in early trading. Markets rebounded somewhat before closing, but all of the major stock indices ended slightly down.The Dow Jones Industrial Average Index closed down 128.11 points, at 11,971.19, a 1.06% drop. The Standard & Poor’s 500 Index fell 14.69 points, to 1,310.50, a 1.11% drop. European stocks bounced back slightly late in their sessions on the Fed news, with Germany’s DAX-30 shooting up 221 points to 6,837, but still closing down 20.72 points, or 0.31%, at 6,769.47.In a statement, the Fed said, “The committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households.”Fearing that lower interest rates will increase inflation, investors unloaded their dollars for gold and other currencies yesterday.The U.S. Dollar Index, which tracks the value of the greenback against other major currencies, was down 0.7%, to 76.311. The dollar also fell sharply against gold on the New York Mercantile Exchange, closing at 1/890th of an ounce of gold a dollar, down from 1/881st of an ounce.“We’re seeing a flight to safety,” the chief economist for Mesirow Financial Holdings Inc., Adolfo Laurenti, said. “People see that stocks are going down, that interest rates are going down, and that there is a real concern about inflation and the direction of the economy. If you want to have a safe investment today, you buy gold.”A senior fellow at the Council on Foreign Relations, Benn Steil, cautioned against rising inflation, and said the Fed has “simply abandoned pursuing price stability in an attempt to produce growth.”According to Mr. Steil, the Fed has responded to recent charges that it is creating too much inflation by pointing to relatively stable “core” inflation rates, which exclude the volatile price changes of food and energy.However, Mr. Steil said the price of food and oil should not be ignored, as they are directly linked to the effects of the Fed’s monetary policies. Lowered interest rates lead to a weaker dollar, which makes energy more expensive to buy, and food more expensive to produce, Mr. Steil said.The Fed also said in its statement yesterday that “appreciable downside risks to growth remain,” and that it would “act in a timely manner as needed to address those risks.” Economists widely predicted that the Fed would make further rate cuts next week, during its scheduled meeting on January 29-30.“The language in the accompanying statement did nothing to dissuade the expectation of more easing,” the chief U.S. economist for JPMorgan Chase, Michael Feroli, wrote in a research note. The chief U.S. economist for IDEAglobal, Joseph Brusuelas, wrote that he expects the Fed to cut interest rates again next week by as much as 0.50%.According to Mr. Laurenti, such unexpected moves from the Fed have historically caused significant stock market rallies.“I think the reaction of stock markets today is quite disappointing,” Mr. Laurenti said. “It’s almost a slap in the face for the central bank.”Mr. Steil said the major indices’ inability to end their fifth straight day of declines shows that traders recognize America’s economic problems cannot be fixed by interest rate cuts alone.“The deeper, more underlying problem is the inter-bank credit crunch. Banks are unwilling to lend to each other for more than a night because they’re afraid that they’re not going to get their money back,” Mr. Steil said. “The Fed cutting rates doesn’t change that.” Presidential candidates generally reacted positively to the rate cuts.In a speech, Senator Obama said, “For the second day in a row, the global stock market has continued to plunge as the world continues to fear that the United States government won’t do enough to prevent a recession. … It’s a fear that hasn’t just confined itself to those who nervously watch the tickers or scan the headlines of the financial section, but one that I have seen on the faces of working Americans in every corner of this country long before anxiety ever hit Wall Street.”The interest rate cut should benefit American homeowners, according to the senior vice president of Preferred Empire Mortgage Company, Jeffrey Appel. “For folks with home equity loans, this is terrific news,” he said. “It will also lower interest rates, which will prompt some people to actually buy into the market.“At the margin, I think the interest rate cut will help the wider economy by helping to create some movement in the housing market,” Mr. Laurenti said.

Fed Move Has Economists Worried About Inflation

Fed Move Has Economists Worried About Inflation

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