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Fedspeak in Plain English: What Bernanke & Co Did Today
January 30, 2008
The Federal Reserve lowered the Federal Funds Rate by half a percentage point today (you’ll also hear people say that it was dropped 50 basis points… a basis point is just 1/100 of a percentage point). Wall Street seems happy, but how does this affect the guy on Main Street?
The Federal Reserve is basically saying that the economy is slowing down, and that they’re willing to accept inflation (and thus the further weakening of the dollar) in order to juice the economy a bit. The problem with faster economic growth is that it almost inevitably leads to more inflation, which tends to create even worse problems than just letting the economy slip a little (for examples of problems with inflation, see Germany in the 1920s or Zimbabwe right now). Inflation is a Bad Thing because it is hard to control without inducing a recession. It may not matter to you that your bottle of beer that used to cost a dollar now costs $1.50, but when something that used to cost a dollar now requires you to carry around a wheelbarrow of money to buy (see picture here), it’s a problem. So every time the Fed lowers rates, it’s playing with fire. Of course, every time it raises rates it risks starting a recession, and sometimes no matter what they do causes problems (as in Japan, where their equivalent of the Fed funds rate has been under 1% for years without helping their stagnating economy).
Right now, we’re down at 3%, after two pretty big cuts. How does this affect your day to day life? Well, to put it bluntly, it punishes savers because banks will lower their interest rates, plus their money is likely to be worth less due to inflation. It rewards spenders, or even better, borrowers of money, because they’ll be able to borrow money more cheaply. If you’re looking to get a mortgage or finance a car, now would be an excellent time to start looking for one. The Fed is telling you to spend, spend, spend and help get this economy moving.
Since lowering the Fed Funds Rate is also great for real estate, we may also see house prices leveling off instead of continuing their downward spiral. I think that asking for another real estate burst like the last one is asking too much; there are other influences keeping the prices of real estate down for the near future. In regards to other investments, a low Fed Funds Rate is, in general, good for the stock market and bad for people looking to buy bonds, Treasury certificates, and other “fixed-income” securities for the income they produce. If you already own bonds, though, they will probably go up in price since they will be offering a higher yield than people will be able to get by buying new ones.
Finally, remember that when the Fed sets a rate, it’s only a target rate. They are actually buying or selling government securities (Treasury bills and the like) to influence the rate (for more information, see this article on Wikipedia). Consequently, everything that I’ve just said will happen in slow motion.. the markets need time to adjust to the new rate and companies need time to take advantage of the lowering of the rate.
(back to A Geek Talks About Money)
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