It’s safe to say that virtually no one expected the Fed’s surprise announcement on Wednesday that it was cutting its target for the federal funds rate by one-half of a percentage point.
Just 15 days earlier, the entire Federal Open Market Committee had conferred and decided to take no action other than to announce a bias toward looser money. They’re scheduled to meet again soon, before the end of the month. So why take action now?
In the two weeks since the Fed met in December, nearly every economic indicator has shown softening. Surveys of consumer confidence carried out nationally and regionally showed increasing pessimism. And the National Association of Purchasing Managers’ index released Tuesday came in below expectations. When the committee met on December 19, there was still nearly a week of shopping left before Christmas, and some sources expected a last minute rush. That didn’t happen, despite sharp, sometimes desperate, discounting by retailers. Cold weather and blizzards raised concerns about high heating bills and natural gas shortages.
Moreover, equity markets, which had responded with an uptick after the last committee meeting, continued to slump, especially the Nasdaq. Its spectacular 7 percent decline Tuesday was conspicuously absent from the Fed’s press release Wednesday. Chairman Alan Greenspan and other committee members have reiterated that central banks shouldn’t attempt to determine the proper levels for equity markets.
Yet the Board of Governors also approved a 25 basis-point cut in the Fed’s discount rate, the rate it charges commercial banks that borrow directly from the Fed.
The discount rate is anachronistic and largely symbolic, but discount-window lending is crucial at times when markets seem to be melting down, as in October 1987. Greenspan, then the new chairman, made it abundantly clear that the Fed would make emergency loans to New York banks whose Wall Street clients faced bankruptcy.
That raises an interesting question: Were there fears of some investment bank going belly up in the wake of Tuesday’s Nasdaq drop? Only the FOMC knows for sure.
The media will focus on the immediate and psychological reactions to the cut, but the fundamental effects of monetary tightening or loosening takes a long time to be felt.
This Fed action may reflect some sentiment on the committee that previous tightening or loosening was too strict and went on too long. And the urgency raises the question of whether Greenspan is empowered to do this on his own initiative. No, it was formally was an action of the entire committee. While the Board of Governors and the presidents of the District Reserve Banks have eight scheduled meets per year, they can also confer by telephone conference call or video conference.
Most likely, it was a contingent decision reached two weeks ago. One of the arguments for not cutting rates then was that the prior meeting, in November, had ended with an announcement of a continued bias toward tighter monetary policy. Some committee members reportedly argued that they should not move from a bias toward tightening at one meeting to a cut at the next without some announcement of a change of bias.
They may have agreed on December 19 to announce a change in bias that day and cut rates two weeks later, contingent on continued negative news about the economy. Such bad news unfolded. A 10-minute conference call would be sufficient to take care of the formalities of a vote.
© 2001 Edward Lotterman
Chanarambie Consulting, Inc.