Pump-Priming Time : Fed needs to cut interest rates now to recharge the economy
With all the talk of recession, it’s time to turn aggressively, but prudently, to stimulating the economy. The Federal Reserve Board seems headed in that direction but it needs to do more. The numbers indicate a slowing national economy, with the Northeast hit the hardest. Decisive action now by the Fed could help other regions of the country help offset the worsening downturn.
The Fed sent a clear signal to banks on Tuesday to loosen up their lending to ease the credit crunch and stimulate the economy. In a highly unusual and symbolic move, the Fed cut reserve requirements on certain deposits for the first time in seven years. That will give the strapped banking industry about $14 billion more to lend, which should improve its profits.
What’s needed now for the economy is an extra kick by the Fed to nudge interest rates down. In normal times, banks cut interest rates if the Fed reduces either the federal funds rate that banks pay on overnight borrowing from each other or the discount rate that banks pay for loans direct from the Fed. That has not been the case this time despite three cuts in the federal funds rate since July.
Banks have been reluctant to reduce interest rates and lend money because of the uncertain economy. That’s been a big disincentive to borrowing by both consumers and business, which only adds to the credit crunch. Economists believe another interest rate cut by the Fed, even by a minimal one-quarter percent, would trigger a round of bank interest rate cuts. That’s why the Fed should reduce interest rates when it meets next week.
It would reinforce the Fed’s unusual cut in reserve requirements and pump even more cash into the economy to relieve the credit crunch. Fed Chairman Alan Greenspan has been exceedingly cautious. But the unusual dynamics of the downturn call for aggressive actions that might not be textbook economics. Caution hasn’t stopped the recession, so erring on the side of pumping up the economy is worth a try.
