Wednesday, December 12, 2007

Central Bank Collusion

So what exactly is the Fed up to? Yeseterday, they lowered the Fed Funds and Discount rates by 25 basis points and the market reacted poorly to say the least. So today a new plan to address the credit crunch is offered:

WASHINGTON (AP) -- The Federal Reserve on Wednesday announced a novel approach to injecting money into the banking system as it struggles to combat a severe credit crunch that threatens to drag the country into a recession.

The Fed said it would conduct two auctions next week where banks can bid for up to $40 billion in loans, money that they will have to bolster their own reserves. It marked the Fed's biggest concentrated effort to inject liquidity into the banking system since the Sept. 11, 2001, terrorist attacks.

The Fed linked the new auction process to an announcement that it was extending a line of credit in dollars to the European Central Bank and the national bank of Switzerland so that those institutions could better deal with credit problems in Europe. The Fed said it was also coordinating with the central banks of England and Canada.

Obviously, this wasn't cooked up over night so it has been in the works for some time, but the question is the timing. Was this in the hopper ready to go in case the rate cut didn't work? Or is this something that would have happened anyway? My guess is the former and when the market gave a thumbs down yesterday, the Fed decided to go with Plan B. From the looks of the market this afternoon, they may want to consider Plan C, whatever that is.

One thing that puzzles me about this plan is that it appears to be a sort of short term lowering of the discount rate. If the Fed wanted to loan money at a lower rate, why didn't they just lower the discount rate more? How is this better? The bottom line here though is that the Fed is attempting once again to get the credit machine functioning again. It seems that the only tool our government ever considers anymore to increase economic growth is monetary. If the economy is in that much trouble wouldn't it be better to be considering fiscal measures such as tax cuts? In fact, wouldn't it be much better for the economy in the long run to leave interest rates where they are and lower corporate and individual tax rates? Why is the extension of credit seen as the only way to improve economic performance? It seems to me that easy credit is what got us in this mess; how is providing more easy credit going to solve the problem?

1 comment:

David said...

Thought provoking, thank you!