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American Economy: Strolling over the troubled waters

Bhuwan Thapaliya - 1/29/2008

Against a backdrop of growing concern about the recession, the central bank of the United States, the Federal Reserve unexpectedly, out of the blue, slashed a key interest rate by three – quarters of a percentage point, from 4.25 percent down to 3.5 percent on Tuesday January 22nd after Federal Reserve Chairman Ben Bernanke and his team approved the huge rate cut after an emergency video conference on Monday night.

The action was approved on an 8-1 vote and this dramatic rate cut has raised concerns about the weakness in the world’s largest economy and has stirred panic all over the world as many analysts had predicted that the US economy could fall into a recession and drag down the rest of the world with it. And their panics and predictions are justifiable because the Fed has honestly stated some harsh economic realities hitting the world’s number one economy in its statement.

For instance, the fed in its statement has candidly stated that an appreciable downside risks to growth remain, and considering so it pledged to act in timely manner to curd the risk facing the economy.

The Fed signaled that further rate cuts were likely, possibly as soon as their next meeting on Jan. 29-30, if the American economic picture looks murky. And the situation is likely to be murkier because a macroeconomic policy takes time to jump from paper policies and act in the real world.

Analysts believe that The Fed is prepared to take the tough rate cut that will be necessary if the economy is not to deteriorate further and shrink into recession as the United States is suffering from declining economic conditions, collapsing house markets, deteriorating stock markets and the gloomy job prospects.

Meanwhile, some economists are asking, “Is interest rate cut the only solution to curb the likely recession and the contemporary economic gloom?” Their argument holds ground because before Tuesday’s move, the Fed had cut interest rates three times, beginning in September

But what has these rate cuts done; its contribution has been minimal. And most importantly, Fed has neglected the concerns about inflation and the inflationary pressures. Inflationary pressures are growing as crude oil prices hit the US$100 level though it has depreciated after that but it can rise any time given the soaring demand for oil and energy. Has it forgotten that reduction and re- reduction of the interest rates in the long run could lead to inflation or is it not giving much attention to this grave economic reality? Normally, a central bank raises interest rates to control inflation or cool the economy. Herein, critics question the Fed’s ability to stabilize the economy.

Should it risk another recession? No. But Fed fears that recession is lurking towards its door. And on the other hand, the treasury, wanting interest costs to stay low on the greatly expanded national debt and the current account crisis, put strong pressure on the Board to follow an easy- money policy. But the monetary policies of the Federal Reserve Board have often been controversial. With due respect to the history, it is clear that mistakes were made in the past, though it would be unfair to place all the blame for these hard times on Fed’s monetary policy as today’s world in interrelated.

What happens in Lahore will have an impact in London and what happens in Moscow ; will have an impact in Brazil . Considering this neo- geographical reality, made possible by the factors of globalization and the technology (mainly the internet), no single nation can remain in isolation. Hence, America ’s fight against terrorism, Bank failures, its economic graveyard in Iraq , and unending war in Afghanistan followed by the rising price of the oil has decapitated the American economy.

Meanwhile, Monetarist believed that the Great Depression of the 1930s was caused by a reduced money stock due to widespread bank failures. And this has ringed an alarm bell for the Fed because global stock markets are freefalling and the risk of serious financial- market meltdown cannot be underestimated at this critical juncture.

The stage is set for the recession in the U.S, and the policy makers are sensing it, as exemplified furthermore by The Bush administration’s $150 economic stimulus package, to accelerate the pace of the economy. But most economist think it shall not occur, not for a year at lest, but the fact that the Fed did not wait until its meeting next week to cut rates and the fact that Bush and Treasury Secretary Henry Paulson conferred with congressional leaders at the White House, looking for a way out underscored the gravity of the American economy.