Tags: Fed | Rate | Cut | Fuels | Markets

Fed Rate Cut Fuels Markets

Wednesday, 18 April 2001 12:00 AM

A stock market that was already rallying rocketed on the news.

The Fed cut its Fed Funds interest rates by 50 basis points (half of 1 percent) to 4.5 percent. This is the fourth 50 basis point cut so far this year. The Fed justified its decision to cut rates between its scheduled meetings by warning that "capital investment has continued to soften." It warned, too, that "the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad threatens to keep the pace of economic activity unacceptably weak."

The Fed's move comes as a surprise in part because the stock market had already been rallying from its recent lows. Tuesday, the Dow closed 8.8 percent up on its March 22 low of 9,389. And a stronger rally had been seen in the NASDAQ index, which had risen by 14.9 percent from its April 3 low to close at 1,923 yesterday.

The stock market was rallying because it had begun to form the view that the economy and the market was bottoming out and that the second half of this year would be better. That view has been reinforced by today's rate cut. Yet Greenspan has made the cut with the belief that the economy is still weak and needs help.

Today's rate-cutting Greenspan seems a world away from the Greenspan of December 1996 who warned of "irrational exuberance." Now Greenspan is concerned about "reductions in equity wealth." His regular rate cuts are intended to sustain the stock market, not just the economy. How wise is his policy?

Greenspan may have felt free to cut rates further Wednesday because the consumer price index released Tuesday showed an inflation rate in March of 0.2 percent and 0.1 percent on a seasonally adjusted basis, which took the annual inflation rate down to 2.9 percent from 3.4 percent in December 2000. Lower energy prices and a slowing economy are bringing inflation down. But does this automatically give Greenspan room to slash rates?

Greenspan has moved further and further away from the stance of a traditional central banker. In the past, the central banker focused on money and credit growth. The "monetarists" in their number paid attention to monetary growth, to the exclusion of other considerations. Others have looked at the inflation rate, which is clearly of prime concern, but also the overall state of the economy: the level of growth, employment, the external accounts, the exchange rate. But Greenspan seems to have gone beyond this, to the point where the overall state of the economy and the stock market matter and monetary growth, which is what he controls, does not.

Monetary growth in the United States is now very high. The broad (M3) money supply rose at an annualized growth rate of 12.8 percent in the three months from December to March, by comparison with the previous quarter. (By comparison, the European Central Bank's favored measure of broad money growth, M2, is rising at an annual rate of 4.7 percent, and the ECB wants to get it down.) The Fed is pushing money into the economy to forestall a slowdown.

This policy could be dangerous. U.S. companies and individuals are being encouraged to borrow at a time when savings rates are at record lows and the trade and current account deficits are at record highs -notwithstanding the fall in February's trade deficit. Property prices have soared in many metropolises in recent years. Is this the time to stoke the asset price boom?

There can be little doubt now that the U.S. stock market's 1995-2000 boom was excessive and helped to fund the U.S. economic boom. That bubble had to burst and is doing so. America's number one central banker is trying to pump it back up.

Copyright 2001 by United Press International. All rights reserved.

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A stock market that was already rallying rocketed on the news. The Fed cut its Fed Funds interest rates by 50 basis points (half of 1 percent) to 4.5 percent. This is the fourth 50 basis point cut so far this year. The Fed justified its decision to cut rates between its...
Fed,Rate,Cut,Fuels,Markets
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2001-00-18
Wednesday, 18 April 2001 12:00 AM
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