Why Another Rate Cut Could Do More Harm Than Good

by Joseph · 2 comments

in The Economy

It’s clear that the root cause of the financial difficulties that we’re facing in the United States is not related to credit being too expensive. It’s quite the opposite in fact – credit is cheap right now but many banks are actually cutting back on lending. So what gives? Why are we sliding into a recession when the Fed has done just about everything that they could to avoid the “r” word?

To be honest with you I don’t truthfully understand everything that’s gone wrong to put our nation and the world in the situation that it’s in. It’s been a long and a drawn out process that some say has been 25 years in the making. Therefore it’d be near impossible for me to cover such a heavy topic on a blog.

Another Rate Cut May Be Near

Something did catch my eye while I was skimming the financial headlines that’s basically directly related to this current crisis and I want to talk about what I read and what I think about it. The Federal Reserve of the United States recently alluded to the fact that they may be making another rate cut in December.

What?

Didn’t we already establish that credit is not expensive? If you remember the last time the Fed cut rates to where they are at now I complained about the rate cut. I was a little annoyed, but to be honest now I’m upset. I think the central bank has forgotten some important details about the current crisis. They’ve forgotten that the American consumer has a great deal of influence in the state of the economy.

Let’s talk about this. I want to hear your opinions and I want your feedback, but more importantly I want to tell you why I think that another rate cut would be foolishness of foolishness.

Why Another Rate Cut Won’t Do Any Good

Another rate cut truly won’t have any affect on how willing financial instituations are going to be to lend money to one another. They aren’t likely to lower consumer loan rates. They will however have a near-immediate impact on consumer savings rates. You think your savings and cd rates suck now? Another rate cut will drop those even more.

It seems to me that these cuts are being made on a purely psychological basis. Almost as if they’re saying that they’re willing to do anything to get the economy back on track. That’s great and all, but is this really going to excite the average consumer? Are they going to see another rate cut and sigh a sigh of relief thinking that their money is going to be safe and we won’t go into a deep, dark recession? Not likely.

Uncertainty Leads to a Recession

The cause of just about any recession goes far beyond actual slowdowns in lending and consumer purchasing. It’s almost always intensified by uncertainty.

People are afraid right now. Truly afraid. If that’s the case then does it seem best to drop rates? I’m actually of the opinion that leaving rates the same could be more beneficial than a rate cut.

The news reports rate cuts nowadays as if they are some sort of super relief element used by the Fed to stop a recession dead in its tracks. Therefore the consumer thinks that a recession is a likely scenario. They stop spending and they start worrying. Suddenly we’re facing a recession. Why? Self fulfilling prophecy.

My Hypothesis on the New Psychology of Rate Cuts

I’m proposing then that a rate cut is more devastating (psychologically) to the average consumer in times of financial crisis than it would be to leave rates the same. By cutting rates the Fed is signaling that they’re afraid and they don’t know what’s going to happen. Let’s leave rates alone for once and see what happens.

You never know.

{ 2 comments… read them below or add one }

AccountingElf November 18, 2008 at 10:11 pm

I loved economics when I took the classes, but one of the things I learned from them is that economists don’t always know what’s going to happen. This situation is a new one for us- no “expert” is guaranteed to be right in this situation.

Bernanke is an expert on the Depression, so maybe that’ll help him make more educated decisions than other people. However, this situation has enough differences from that one that he can’t only use that (and I’m sure he’s not only basing it on that.)

I think that American consumers do need to slow down their consumption somewhat, although I’m sorry a lot of people had it brought to their attention this way. It’ll be interesting to see if people’s behavior shifts for the long term from all of this. I agree with you that the consumers will have a big effect.

At the same time, the rate cut may help big financial institutions in ways that individual consumers don’t really see directly, but it might help keep things stable, which is what they’re aiming for. It’ll be interesting to see, and we’ll all have sometime new to study in econ classes in 80 years time.

AccountingElfs last blog post..How to start a small business without quitting your day job

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Susy Ting March 10, 2010 at 3:45 pm

Really great article – I was thinking about a similar article which I will probably still take a shot at, but from a slightly different angle. Thanks for sharing this with your readers…I’m sure I’m not the only one who appreciates it.

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