The Fed Needs To Cut Interest Rates To Zero

September 30, 2008 by Douglas A. McIntyre

FedUp until recently, the Fed had a good reason not to cut interest rates. Inflation might catch hold of the economy and undercut the purchasing power of individuals and corporations alike.

Inflation does not look like much of a leviathan any more. Oil has dropped from $147 to $94 in a very brief time. Agricultural commodity prices are dropping almost as fast. The money that the Fed has pushed through its emergency lending window, now well into the hundreds of billion of dollars, has done nothing beyond strengthen bank reserves. Not a trace of it has shown up in the lending markets.

The prevailing wisdom is that Congress will eventually come up with a bailout package for financial institutions and mortgage-holders. That was the prevailing wisdom yesterday and it turned out badly. Counting on a legislature where every representative is up for re-election is worse than betting on a game of Three-card Monte on a New York City street corner. It is all risk and no reward.

The largest single advantage that the Fed has in a financial crisis is that it can act alone. It operates without permission and only the most modest regulation.

Cutting rates to zero will certainly not cost the government and taxpayers $700 billion. It might well free up some of the credit which is currently frozen in place. It would certainly tranquilize some of the market’s hysteria. It would leave the impression that there is some will to power left in the institutions put in place to keep the financial world orderly.

Purists would argue that it is not the Fed’s job to exercise broad powers. It should have as its sole focus issues of inflation and deflation. It should never be an activist agency. That is the province of the portion of government run by elected officials.Precedent would argue in that direction.

Since the dike of government protections has been ruptured, precedent may have lost a great deal of its charm. There are no institutions left which can take immediate and direct action, with the exception of the Fed.

Douglas A. McIntyre