Tuesday, December 16, 2008

Fed Drops Fed Funds Rate To Zero

Well, it looks like the Fed wasn't going to take any chances, they played all their interest rate cards as they dropped the target federal funds rate down to the 0 to 0.25 percent range. They obviously were trying to send a powerful message since most investors and economists only predicted a 0.5 percent reduction. It will be interesting to see how this plays out, but the U.S. has officially won the race to zero. Economics professor Mark Thoma from The Economist's View looks closer at this new development, and brings in some additional outside thoughts and opinions, in his blog post below.

The Fed announced it will move the target federal funds rate into the zero to .25% range, an that it plans to keep it there for some time.

Here's the Fed's statement:

Press Release: The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent.

Well, that's it, we're at zero now. Any further monetary policy action will have to come through other means, e.g. quantitative easing and the purchase of financial assets.

Brad DeLong adds:

Hale "Bonddad" Stewart Is Scared: The Federal Reserve reacts to the fact that the economy train has arrived in Depression City.

Stewart writes:

Hale "Bonddad" Stewart: The Fed's Kitchen Sink Interest Rate Policy: The Fed announced their policy of establishing "a target range for the federal funds rate of 0 to 1/4 percent." This brings two points to mind:

  1. The Fed has no interest rate moves left. This is it.
  2. The Fed is terrified about the economy. And they have good reason:

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further....

The Fed will step up their other activities...

To the point: the Fed is scared right now. I mean really scared. And they will do anything even remotely possible right now.

Paul Krugman:

ZIRP!: That’s zero interest rate policy. And it has arrived. America has turned Japanese.

This is the thing I’ve been afraid of ever since I realized that Japan really was in the dreaded, possibly mythical liquidity trap. You can read my 1998 Brookings Paper on the issue here.

Incidentally, there were a bunch of us at Princeton worrying about the Japan problem in the early years of this decade. I was one; Lars Svensson, currently at Sweden’s Riksbank, was another; a third was a guy named Ben Bernanke. I wonder whatever happened to him?

Seriously, we are in very deep trouble. Getting out of this will require a lot of Show allcreativity, and maybe some luck too.

This post can also be viewed on economistsview.typepad.com.

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