[ShinyOldLady]

This is probably a very basic economics question, but American business folk seem to think that a cut in the fed's prime lending rate will solve all our housing and economic problems. What is the downside? If cutting the rate is all that's needed, why don't they just set it at something like .5% ? That way we would see incredible prosperity (?)

[Micki]

That would not lead to prosperity.
It would lead to more loans/leverage meaning more money is out there buying the same stuff, which leads to competition in buying which leads to higer prices.
Increased money supply leads to inflation.

Secondly, investors loose interest in interestbearing intruments and more likely move their money overseas where the interest rate is better.

Similarly there is little incentive for people to save money as prices are shooting up and interest rate on saving is low.
This leads to people borrowing more (as it is cheap) and buying stuff, which constantly increases in price = hyper inflation.
Do some search on Weimar Republic for excellent case.

Finally foreign investors seeing the currency weakening and interest rates being low would move away from the currency leading to a currency crash = expensive imports.
For a nation that isn't exporting or at least self sufficient in produciton of goods, this would lead to a drop especially in consumer discretionary spending, which then leads to unemployment etc.

Not a totally comprehensive explanation but at least to get you started. Secondly I suggest you spend some time at Safehaven and read up as much as you can.

[essex]

The downside is the belief that things will continue as always. $82 oil is a strong signal that the US$ will decline further and feed into an inflationary spiral. Add in oil depletion and the disasterous export land model of consumption and you get "real " asset appreciation, oil, gold , sliver etc along with currency turmoil to the detriment of the economy. New Zealand where I live faces an even worse situation - we import 87% of our oil.

[emersonbiggins]

Some rumblings of the unwashed masses over at Fark suggest that this rate cut will stimulate exports by encouraging innovation in the service industries (I.T., for instance) and that the weaker dollar will encourage other countries to purchases said services, creating demand, increasing wages and jobs. I suspect they are seeing the rosiest of outcomes, ignoring several white elephants lurking around in the meantime.

[Johnvancouver]

This will further encourage the mindless consumption and accelerate the rate of resource depletion. Our phony growth calculation does not take into consideration the resource depletion and environmental costs. More paper money will be created as a result. But that’s not real wealth. The real wealth is our natural resources and our environment which are relentlessly consumed and damaged. We are burning our house down to keep ourselves warm. This 0.5% cut adds fuel to that fire!

[Micki]

$this->bbcode_second_pass_quote('', 'T')his will further encourage the mindless consumption and accelerate the rate of resource depletion.

[Heineken]

$this->bbcode_second_pass_quote('Micki', '')$this->bbcode_second_pass_quote('', 'T')his will further encourage the mindless consumption and accelerate the rate of resource depletion.

[RacerJace]

One up side to the inflationary low interest condition is that you can take out a fixed interest loan and buy a tangible asset (eg. property) with the money. Provided you have a secure income that is growing with the inflation rate, you can sit back and watch the real value of the mortgage wither away as the unit currency loses it's value.

The key is to be able to endure the high inflation because the cost of everything will be rising. The aim of this Bernanke move is stop the housing market wound from bleeding out. Problem is most people's income will not be stable as a recession goes hand and hand with rising unemployment and/or stagnant wages.

The root cause of this and many more future recessions is rising commodity prices, especially oil. And risk aversion (fear) perpetuates and spreads the problem across different industry sectors (eg credit markets). Demand destruction will cause the whole cycle to repeat over and over again until we wake up one day and say "remember the days when you could get fresh OJ imported from Brazil" and then really wake up and shudder at stench of death in the air.

I personally don't think Bernanke’s maneuver will stabilise things for long. Once the real fear (and knowledge of peak oil) permeates and sets in with the world economies, the capitalistic game is going to be in checkmate.

[billybell88]

If they lowered the rate to sometime like .5%, then that would lead to hype inflation....and fighting inflation is one of the Federal Reserve's main missions.

[ShinyOldLady]

Thanks, Micki, for the excellent reference to Safehaven. It is explaining a lot to me.

[Doly]

$this->bbcode_second_pass_quote('Micki', '
')Increased money supply leads to inflation.

[aahala]

An inaccuracy doesn't become accurate simply by repeating it,
even a zillion times.

The Fed does NOT set the fed funds rate. What they set is
the target for the fed funds rate. Sometimes they are successful
and sometimes they aren't in their most usual case of trying
to drive the rate to the target set.

Their two main tools have both practical and staturory limits.
They can buy or sell securities, which changes the money supply
and (less often) change the reserve requirements.

The fed funds rate is the price banks are charging one another
for the "excess" or "shortage" of reserves held by the fed. The
fed does calculate the actual rate, but they are merely a clearing
agent in this regard.

Sometimes, the fed will change the target to the actual, existing
fed funds rate. By doing so, they are announcing their judgment
that the existing rate is in line with their public mandate to keep
inflation in check, keep the economy going, yada yada yada.

[MOCKBA]

The effect of the fed rate cut is that Aerobus is no longer a competitor to Boeing, thank you very much. Apple would make a very good coin since 40% of revenue comes from outside of North America (and North America includes Canada where they would pay 50% more for Apple products than Americans). And Best Buy just reported that they managed to pull 3+% in same store sales even prior to FEDs present thanks to Canadians who bought 16% more stuff from them since Canadian Tire, Bay, etc ain't competitors anymore either.

[timbo]

Hey cheer up you lot. The nukes haven't started going off yet.

[Johnvancouver]

Micki, with helicopter Ben at the helm of the Fed, don't you worry about deflation. Lowering the fund rates is only their open act to inflate. They are probably also secretly monetizing the US debt, buying up the rotten loans off the banks' balance sheet and spending billions to prop up the markets. All these amount to paper money printing and are highly inflationary. Now they are also trying to get Fanny and Fredi to increase their insured loan limit (which currently stands at $417,000) hence protecting and perhaps further fueling the huge housing price inflation of the last three years. Hyperinflation already happened in certain sectors of the economy and it can happen even when the rate is higher than 0.5%.

I come back to my view that the main problem we have is that our current measure of growth and economic performance do not take into consideration the resource depletion and environmental destruction. So to retain this phony growth and prosperity, governments will inflate and inflate to keep the consumption (yeah, that's our main economic activity) going until we hit some physical constraint, be it oil depletion or severe consequences of global warming. Until then, inflation will keep going up, savers will get hit, and reckless spenders will be rewarded. In the end, Mother Nature and hence us are all doomed.

[MOCKBA]

$this->bbcode_second_pass_quote('MOCKBA', 'T')he effect of the fed rate cut is that Aerobus is no longer a competitor to Boeing, thank you very much.

[Johnvancouver]

I should add that under the existing measure of growth and economic performance, the inflationary policy is perhaps pro-growth and the right thing to do. So you actually cannot fault BB and friends that much. But it's a misguided policy under faulty measures as we seek to expand our already overweight consumption based economy at the expense of our real wealth, which are our natural resources and our environment. This just cannot last forever.

[FoxV]

surprised it hasn't been brought up yet but one of the things the FED rate cut did not do was lower interest rates for homeowners, or changed anything to do with the seize up of the credit markets.

Bernanke's Bullet Misses the Mark

It did however have everything to do with lower short term rates so Big banks would stop taking a hosing between the difference of short term rates (the money they borrow) and the lower long term rates (the money they earn). And guess what the difference between short and long term rates was before the FED cut, yup, 0.5% (sorry, can't find the link anymore, I think it was posted in the Housing bubble collapse thread)

Now I could be wrong and its just a coincidence, but it leaves the question; is the FED evil or incompetent?

I'm sure the Chinese are asking themselves that very same question as well

edit---
found the link
Sudden Debt
All holders of US assets sold out to temporarily help a couple of banks. Didn't realize your worth so little did you?

[Euric]

$this->bbcode_second_pass_quote('MOCKBA', '')$this->bbcode_second_pass_quote('MOCKBA', 'T')he effect of the fed rate cut is that Aerobus is no longer a competitor to Boeing, thank you very much.

[truecougarblue]

The fed rate cut will only serve to lengthen the coming economic malaise vis a vis Japan in the 90s. Think of it as pushing on a string.