Further rate cuts needed

The Fed will probably vote for another 50-basis-point cut in the fed funds rate this week, bringing its target down to 1%. Here’s why I think that would be a good idea.

First, the current fed funds target of 1.5% remains 50 basis points above the 3-month T-bill rate. That gap is the one factor contributing to the worrisome TED spread that the Fed clearly has the power the change.

tbill_ff_oct_08.png

Second, I have a hard time seeing a resurgence of inflation in the current troubling economic environment, in which plunging demand has brought oil back below $70 a barrel, and the big concern is that we’re about to see a surge in the unemployment rate.

Third, the primary worry that would prevent the Fed from cutting rates at the moment is the prospect of triggering a flight from the dollar. But the problems have clearly gone global now, with other central banks likely to cut as much or more as we do. I’ve been a little surprised at the flight back into dollars that those global developments seem to have instigated.

Would another 50 basis points really help? Maybe not much. But I expect we’re about to find out.


Originally published at Econbrowser on Oct 27, 2008 and reproduced here with the author’s permission.