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Reason for Fed Funds Rate Cuts Now Clear

So now we know. Or at least we have been given (yet again) information as to why the FED raises and lowers interest rates. This, we must come to understand, is the main tool they have (and only they have) for influencing the rate at which our economy moves.

All through the early years of this decade we wondered just exactly what "they" were up to... They raised the rates a quarter basis point at a time, many times in a row. They talked of the threat of inflation, they talked of moderating growth to manageable levels, but here's the truth: With rates as low as they were in the years 2002, 2003, 2004 there was no room to move when the economy slowed... as it always does after a period of sustained growth!

Yep, that's it in a nutshell. But if you need a drop in interest rates to spark a sluggish economy, or for any reason, better make sure that you have previously raised rates or you'll have no room to drop them!

Oh, I know that the Fed can accelerate the money supply, as their other tool, but in case you haven't noticed, foreign investment in this country has accelerated such that the domestic money supply has a decreasing influence on our growth. So we're left with the stark reality that other than the psychological variable we laughingly call "consumer confidence" (over which the Fed has no influence except in so far as interest rates themselves change public perceptions of how good things are) the prevailing interest rates are it, the whole shebang.

The cycle we seem to be heading into, early in 2008, is one that was inevitable (a normal correction after several strong growth years). If the interest rates had remained as low as they were four or five years ago the housing problems we now are encountering would have been far worse than we're currently experiencing; which by historic standards are pretty routine. Inflation (especially in real estate) would have been anything but routine, and there would have been no room for the Fed to drop rates.

When it rains, get out your umbrellas. When the economy slows, the Fed's umbrella is rates that are high enough that they can drop them. They did, they will do some more, and guess what? It will stop raining soon enough... it always does.

Learn more about this author, Arch Barnes.
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