interest rates cut to save the economy

[maladroit]

Fed cuts interest rate by 0.75 points
Last Updated: Tuesday, December 16, 2008
CBC News

The U.S. Federal Reserve has cut the country's short-term interest rate by three-quarters of a percentage point to a target range of zero to 0.25 per cent.

That is the lowest level on record for the United States.

In announcing the cut Tuesday, the Fed said U.S. labour and market conditions, consumer spending, business investment and industrial production are all falling.

"Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further."

The economy is so bad that the rock-bottom rate is likely to continue for some time, the central bank said.

[maladroit]

Monday, 19 March, 2001, 18:37 GMT
Japan cuts rates to zero

The Bank of Japan has brought back its zero per cent interest rate policy, in an effort to boost the country's ailing economy.

And it has guaranteed to keep the ailing banking sector afloat by flooding the economy with money if a major bank was threatened with bankruptcy.

Should there be a risk of financial market instability..the Bank will provide ample liquidity irrespective of the guidelines

Financial analysts are doubtful, though, whether the new policy will help the economy. With rates already close to zero, the move is more of symbolic than economic value.

[GoldenBoy812]

All these moves do is give the central banks an unbelievable amount of power to curb inflation. As the target approaches 0, and prices continue to fall (deflation), the next move is a massive spending spree.

John Browne (http://video.google.com/videoplay?docid=-6467068244130108133&hl=en)

As Mr. Browne states around minute 3, spending might precipitate to $10 trillion before it is all said and done.

[maladroit]

questions:

deflation is really bad if it's coupled with a depression, no?

if the fed is dramatically increasing the money supply, why isn't inflation rising?

is $10 trillion in spending over 2008 - 2009 possible? do you think his projection that $10 trillion will be needed to avoid a depression is accurate? with that kind of spending, obama might double the national debt

[GoldenBoy812]

questions:

deflation is really bad if it's coupled with a depression, no?

if the fed is dramatically increasing the money supply, why isn't inflation rising?

is $10 trillion in spending over 2008 - 2009 possible? do you think his projection that $10 trillion will be needed to avoid a depression is accurate? with that kind of spending, obama might double the national debt


1.) Deflation is just as bad as inflation. Most people would think that lower prices is a good thing, and it is. The other side of that coin is that lower prices will eventually translate into lower wages. As wage deflation takes hold, that is when things get very bad. Wage deflation will cause a recession.

2.) Even though the fed has filled the reserves of banks to the max, they are not lending. Click to see excess reserves (http://www.federalreserve.gov/releases/h3/Current/) As you can see, at the end of August, the "credit crunch" was born, and lending became scarce.

To put it into even greater prospective: With a required reserve ratio of 1/10, you have a money multiplier of 10. The amount of excess lending capacity (how much banks can actually lend out) in July of 2008 was about $20 billion, and as of November 08, it was (theoretically) over $5.5 trillion. Yet with deflation setting in, their holdings will actually increase in real value. Why risk a potential default when prices are still falling (the $'s value is still rising)? This is what is commonly described as a liquidity trap.

So as they are increasing the supply of the money, it has yet to be released. Cash is king, people are taking their money out of the economy, and therefore no matter how much money the fed pumps into the bank reserves, until its lent out it is not in the economy.

Prices continue to fall due to a decrease in aggregate demand. If nobody is demanding goods, the only way to create revenue is to decrease prices.

3.) I believe Mr. Browne was referring to the next 4 years or so. As stated before, the national debt is not as scary as some make it out to be. With that said, as long as foreign holdings do not increase relative to overall debt it is nothing to worry about. This seems to be Keynesian approach to recession alleviation, as Japan floated their debt to gdp at 130%, and the US @ 120% after WWII.

Which is why i believe him to be correct, that it is the only way to avoid a full scale recession. An increased $10 trillion in debt will put our debt to gdp over 142% give or take, so that is not at all out of the realm of possibilities if things do in fact get desperate.
------------------------------------------------------

As i said before, with the FFTR approaching zero, they might be able to alleviate future inflation possibilities.

[maladroit]

thanks for the detailed reply...it cleared up a couple issues but i'm still confused about a lot of things...i hope you don't mind if i pick your brain later

lookee what i found just now...i think bernacke is turning japanese, i think he's turning japanese, i really think so



Bernanke's Japanese edge

MARCUS GEE AND BRIAN MILNER

From Wednesday's Globe and Mail

December 16, 2008 at 10:53 PM EST

In 1999, an American economics professor by the name of Ben Bernanke addressed an issue that at the time was fascinating mainly to other economists: What do you do when you cut interest rates to the bone and nothing happens?

That was the problem facing Japan. Confronted with an economy that was down and refusing to get back up, the Bank of Japan (BOJ) had reduced rates nearly to zero, just as the U.S. Federal Reserve is doing now. Nothing happened.

What to do? Mr. Bernanke, a student of the Depression and of Japan's â??lost decadeâ?� of the 1990s, grappled with the question in a paper.

â??Having pushed monetary easing to its seeming limit, what more could the BOJ do? Isn't Japan stuck in what Keynes called a â??liquidity trap'?â?�

To the contrary, he said, â??there is much that the Bank of Japan could do to help promote economic recovery in Japan â?¦ a more expansionary monetary policy is needed.â?�

What he meant was a policy of â??quantitative easingâ?� â?? flooding the banking system with money with the aim of easing pressure on banks, persuading them to start lending again and prevent a downward spiral in prices.

That is precisely the policy that the Bank of Japan adopted from 2001 to 2006, becoming the only modern central bank to, in effect, print money while at the same time keeping rates at rock bottom.

Now, faced with a crisis of his own, Mr. Bernanke, as chairman of the Fed, appears to be embarking on a similar course â?? and no one is quite sure where it will lead.

When the Fed announced yesterday that it was cutting rates to between zero and 0.25 per cent, it noted that it was buying up mortgage-backed securities and was considering whether to buy long-term Treasury securities.

That was a strong signal that Mr. Bernanke is about to put his academic theories into practice, with trillions of dollars and the fate of the world economy at stake. Ever since a 2002 speech in Washington where he talked about what to do if deflation hit the United States, he has been musing about how central banks might pump money into a failing economy if interest rate cuts weren't working â?? then considered a remote possibility at best.

In that speech, which earned him the nickname â??Helicopter Ben,â?� he referred to the remark by the renowned Chicago economist Milton Friedman that governments could theoretically just drop piles of money from helicopters. That helicopter drop is now on.

Since the crisis began, the Fed has moved aggressively to thaw frozen credit markets and get banks lending into the marketplace again.

Among other measures, Mr. Bernanke has turned to quantitative easing since mid-September, essentially printing billions upon billions of dollars and pumping them into the financial system â?? at a level far in excess of what's required to maintain the Fed's target interest rate for interbank borrowing.

[GoldenBoy812]

thanks for the detailed reply...it cleared up a couple issues but i'm still confused about a lot of things...i hope you don't mind if i pick your brain later

lookee what i found just now...i think bernacke is turning japanese, i think he's turning japanese, i really think so



Bernanke's Japanese edge

MARCUS GEE AND BRIAN MILNER

From Wednesday's Globe and Mail

December 16, 2008 at 10:53 PM EST

In 1999, an American economics professor by the name of Ben Bernanke addressed an issue that at the time was fascinating mainly to other economists: What do you do when you cut interest rates to the bone and nothing happens?

That was the problem facing Japan. Confronted with an economy that was down and refusing to get back up, the Bank of Japan (BOJ) had reduced rates nearly to zero, just as the U.S. Federal Reserve is doing now. Nothing happened.

What to do? Mr. Bernanke, a student of the Depression and of Japan's â??lost decadeâ?� of the 1990s, grappled with the question in a paper.

â??Having pushed monetary easing to its seeming limit, what more could the BOJ do? Isn't Japan stuck in what Keynes called a â??liquidity trap'?â?�

To the contrary, he said, â??there is much that the Bank of Japan could do to help promote economic recovery in Japan â?¦ a more expansionary monetary policy is needed.â?�

What he meant was a policy of â??quantitative easingâ?� â?? flooding the banking system with money with the aim of easing pressure on banks, persuading them to start lending again and prevent a downward spiral in prices.

That is precisely the policy that the Bank of Japan adopted from 2001 to 2006, becoming the only modern central bank to, in effect, print money while at the same time keeping rates at rock bottom.

Now, faced with a crisis of his own, Mr. Bernanke, as chairman of the Fed, appears to be embarking on a similar course â?? and no one is quite sure where it will lead.

When the Fed announced yesterday that it was cutting rates to between zero and 0.25 per cent, it noted that it was buying up mortgage-backed securities and was considering whether to buy long-term Treasury securities.

That was a strong signal that Mr. Bernanke is about to put his academic theories into practice, with trillions of dollars and the fate of the world economy at stake. Ever since a 2002 speech in Washington where he talked about what to do if deflation hit the United States, he has been musing about how central banks might pump money into a failing economy if interest rate cuts weren't working â?? then considered a remote possibility at best.

In that speech, which earned him the nickname â??Helicopter Ben,â?� he referred to the remark by the renowned Chicago economist Milton Friedman that governments could theoretically just drop piles of money from helicopters. That helicopter drop is now on.

Since the crisis began, the Fed has moved aggressively to thaw frozen credit markets and get banks lending into the marketplace again.

Among other measures, Mr. Bernanke has turned to quantitative easing since mid-September, essentially printing billions upon billions of dollars and pumping them into the financial system â?? at a level far in excess of what's required to maintain the Fed's target interest rate for interbank borrowing.

Your welcome:jointsmile:

A couple things to note:

Quantitative easing, other wise known as "printing" along with a 0% target rate translates into what was initially an imaginary term, or a negative rate of interest. Essentially, the federal reserve is paying people to begin taking loans (or banks to make them).

The free market is not really acting free, more so fearful of potential regulations that will hinder potential profits. As money flows out of (all) banks, it tends to be viewed as "inflationary" to the first owner of that money. This sentiment carries, as the newly created money
"trickles down" into the economy, hopefully creating spending that will reflate the cost of goods (AD). Here is what worries me. Private investment can be crowded out more so than it would even during a severe recession. Also, this new money carries the risk of speculative investment that could lead to asset bubbles.

The Keynesian views inflation as an increase in overall prices over a select period of time.

The Austrian views inflation as increasing the money supply, where price increases are one of many symptoms. It create asset bubbles, which cause the business cycle to fluctuate as it does.

In the past (pre 1890's), asset bubbles were created primarily by instances of fraud. Significant fraud resulted in deep recessions and depressions accompanied by deflation.

[Markass]

questions:

deflation is really bad if it's coupled with a depression, no?

if the fed is dramatically increasing the money supply, why isn't inflation rising?

is $10 trillion in spending over 2008 - 2009 possible? do you think his projection that $10 trillion will be needed to avoid a depression is accurate? with that kind of spending, obama might double the national debt

inflation will rise, it's not something that's going to happen overnight but it's going to happen...


what bugs me about this is what if this doesn't 'save' the economy?? What's next? Zero Percent? What if that doesn't do it..

[GoldenBoy812]

inflation will rise, it's not something that's going to happen overnight but it's going to happen...

You mean prices will rise, or prices will inflate. It would seem so, but with the rate so close to zero, every time prices go relatively up they can use open market operations to pull money out of the economy.


what bugs me about this is what if this doesn't 'save' the economy?? What's next? Zero Percent? What if that doesn't do it..

Monetary policy is more of an art from then an actual science. Look for a huge fiscal stimulus package to be used in an attempt to revive the aggregate demand shortfall.

[dragonrider]

Well, I certainly hope that whatever they do with monetary and fiscal policy, they can avoid the deflationary spiral that caused the Japanese "Lost Decade." What we have happening now looks a lot like the same thing to me. As I recall, the Lost Decade began with a similar housing bubble to the one that we experienced. Another thing I remember about the deflation that Japan experienced was the stagnation it caused in the economy --- prices kept dropping, so people would wait to buy anything, expecting it to be cheaper in a month or so. That lowered demand, which lowered prices more, which led to more reluctance to buy. Eventually wages went down. They got stuck in a dwnward spiral. It seems like deflation is actually worse than inflation, because once the interest rates reach zero, there is little left to do (except for the "helicopter" approach --- can I get advanced notice of where this helicopter will be when it starts dumping cash?).

One of the things I have noticed is that right now is a GREAT time to refinance your mortgage (assuming you can qualify). The underwritng standards may be tighter, but the rates are very good. My credit union is offering 30 year fixed rate mortgages at 4.625%! I do not know if I have ever seen rates like that. About 5 years ago, I got a mortgage at 5.625%, and I thought I would never see rates as good as that again in my life --- now it is a full point lower. I'm starting my application in the next few days.

[maladroit]

what are they charging on a 1 year fixed mortgage? you can renew it at the lowest rate every year and pay down as much as you want without penalty

[dragonrider]

what are they charging on a 1 year fixed mortgage? you can renew it at the lowest rate every year and pay down as much as you want without penalty

I don't think they offer that kind of loan. Here is the rate page, with rates for the different types of home loans: https://www.patelco.org/rates/rates.aspx

Note: It changes all the time, so if you look tomorrow, the 30-year fixed might not be 4.625, but today, 12/18/08, it is.

[Weezard]

Well, I certainly hope that whatever they do with monetary and fiscal policy, they can avoid the deflationary spiral that caused the Japanese "Lost Decade." What we have happening now looks a lot like the same thing to me. As I recall, the Lost Decade began with a similar housing bubble to the one that we experienced. Another thing I remember about he deflation that Japan experienced was the stagnation it caused in the economy --- prices kept dropping, so people would wait to buy anything, expecting it to be cheaper in a month or so. That lowered demand, which lowered prices more, which led to more reluctance to buy. Eventually wages went down. They got stuck in a dwnward spiral.

One of the things I have noticed is that right now is a GREAT time to refinance your mortgage (assuming you can qualify). The underwritng standards may be tighter, but the rates are very good. My credit union is offering 30 year fixed rate mortgages at 4.625%! I do not know if I have ever seen rates like that. About 5 years ago, I got a mortgage at 5.625%, and I thought I would never see rates as good as that again in my life --- now it is a full point lower. I'm starting my application in the next few days.


Aloha D.R.

Dunno if the rule applies when rates get this low, but ordinarily, it does not make sense to re-fi for less than 2 points.

When you add the cost of the re-fi and the 5 years lost the deal usually goes :upsidedow on ya.
Easy check? Calculate the monthly for a 25 year loan.
If the payment is still lower than your present payment, go for the 5 more years of debt.

No matter how tricky a deal gets, and consequently, how good it looks, it pays to dig up the bottom line.:)

I ignore all the B.S. and calculate for total cost.
Hope it still works for ya.

Best,
Weeze. ( Cheap?! I prefer Frugal)

[maladroit]

woah those rates are lower than i can get in canada right now...i got my mortgage in late 2001, renewed it on an annual basis, and it never went over 4% (thanks to president bush)

with rates coming down, wouldn't a variable mortgage be better if a 1 year fixed mortgage is not available?

[llama shack]

This may seem deflationary but within a couple of years.... holy hyperinflation.

The Fed is just delaying the inevitable and making the inevitable even worse.


You know what would be cool? If marijuana was legalized and taxed RIGHT NOW, it would cover all these bullshit state budget defecits and a good portion of this incredible amount of deficit spending.

It'd create a ton of jobs, god damn. It really is the answer.

[dragonrider]

Aloha D.R.

Dunno if the rule applies when rates get this low, but ordinarily, it does not make sense to re-fi for less than 2 points.

When you add the cost of the re-fi and the 5 years lost the deal usually goes :upsidedow on ya.
Easy check? Calculate the monthly for a 25 year loan.
If the payment is still lower than your present payment, go for the 5 more years of debt.

No matter how tricky a deal gets, and consequently, how good it looks, it pays to dig up the bottom line.:)

I ignore all the B.S. and calculate for total cost.
Hope it still works for ya.

Best,
Weeze. ( Cheap?! I prefer Frugal)

Thanks, Wheeze. I agree that it would not be worth it to refi for just 1 point from the point of view of paying the lowest interest overall. But I have a few other things going on. You know how things always change, so decisions you made previously aren't working for you now? We had made accellerated payments on our 1st mortgage some time back, so it is paid down by a lot more than the 5 years we've had the loan. Then some time after making those payments we needed cash for a kitchen remodel we wanted to do, so we ran up a second equity line, which has a higher interest rate, shorter term, so a larger payment. And now our income is not what it was when we made some of the previous decisions, so we'd rather have a single lower payment, plus a bit more cash in the bank in case we have any other changes to income in the future. Really, if we had just not made the accellerated mortgage payments in the first place and kept that as cash in the bank, we would not have needed the second mortgage equity line for the remodel, and we'd have the cash reserve we want now. Funny how things work out, but it seemed like a good idea at the time to speed up paying off the mortgage.

I've done this more than once --- paid my loans down with extra cash, then needed extra cash later on and had to borrow it again, at higher rates than the original loan or with fees related to refinancing. I'm thinking I need to keep better cash reserves, even if they don't earn well.


woah those rates are lower than i can get in canada right now...i got my mortgage in late 2001, renewed it on an annual basis, and it never went over 4% (thanks to president bush)

with rates coming down, wouldn't a variable mortgage be better if a 1 year fixed mortgage is not available?

Maladroit, I've always just been more comfortable with the idea of fixed rate loans, rather than variable rate loans. Also, I am not familair with the 1 year fixed mortgage you mentioned. We've had some very exotic loans offerred by some lenders, but I have not heard of that one. Also, my credit union tends to deal in pretty traditional fixed rate or ARM loans.

Anyway, I didn't mean to threadjack this thread to discuss my personal finances. I just wanted to point out that even in an economic crisis, there are some good opportunities. Right now, if you do have access to credit, there are very cheap interest rates, and certain kinds of investments like real estate are very cheap as well. It's just harder to summon the courage to take advantage of those opportunities when you aren't sure what is coming down the pike.