As was widely expected, the US Federal Reserve's Open Market Committee cut short-term interest rates by 50 basis points today, setting the federal funds rate at 5.5 percent. This is the second time this month that the Fed has moved to cut interest rates, ending a 19-month inflation-fighting bias with a pair of quick and robust rate cuts to counteract the threat of a recession.
The US economy is showing signs of strain, with eroding consumer confidence and weakening corporate purchasing power due to rising energy costs. The risk created by these factors is that they could undercut productivity gains that have kept inflation at bay. The FOMC, however, remains optimistic about the productivity gains that are keeping inflation under control, stating, "The longer-term advances in technology and accompanying gains in productivity, however, exhibit few signs of abating and these gains, along with the lower interest rates, should support growth of the economy over time. "Earlier Wednesday, the Commerce Department announced that the US gross domestic product grew just 1.4 percent in the fourth quarter, well short of the 2.2 percent economists had expected, and the lowest growth rate since 1995. On Tuesday, the Conference Board said consumer confidence has dropped to its lowest level since December 1996. In his testimony before Congress last week, Fed Chairman Alan Greenspan said that consumer confidence, more than any other factor, is at the vortex of the risks that can spin a faltering economy into recession.
The Fed made only a passing mention of inflationary risks in its statement, and rather focused on rapidly devolving economic conditions that point to a very real threat of recession. In the statement, the Fed said that "taken together, and with inflation contained, these circumstances have called for a rapid and forceful response of monetary policy."
Financial markets had expected a 50 basis-point rate cut, but there had been rumors that the cut might be even larger. Stocks have reacted to the news by selling off modestly.