Ben Bernanke's great balancing act: the Fed continues to cut rates, but is it all too little too late?

Real Estate Weekly, Jan 30, 2008 by Daniel Geiger

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Responding to criticism that it hasn't taken dramatic enough steps to breathe life into an economy at the cusp or already in a recession, the Fed called an emergency meeting last week and slashed the fed funds rate by three quarters of a point to 3.5%.

"The committee took this action in view,of a weakening of the economic outlook and increasing downside risks to growth," the Fed's statement read.

The move came a day after stock markets plunged around the globe, in part because of fears over the health of the U.S. economy, which has seen flagging job growth, falling consumer spending and a continued decline in the residential housing market.

The cut was followed by a major drop in the Dow Jones Industrial Average, which fell by over 400 points in opening trading last Tuesday before recovering to within 100 points of its opening. The S&P 500 also fell, dropping almost 40 points below its opening of 1,312.94. It too recovered, trading just above that by midday.

The Fed's statement acknowledged the ongoing recovery of the credit markets, but said it wasn't enough to alleviate the problems that have been hitting consumers.

Consumer spending accounts for two thirds of economic activity but has seen a steep pullback as the nation's unemployment rose in December and sagging residential prices and tighter lending standards have significantly curtailed what had in recent years been the popular practice of leveraging home values to access spending money. "While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households," the Fed said.

"Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets."

Weak consumer spending led to slow retail sales during the holiday season.

Rising inflation has also become a growing problem as the Fed's moves to counter an economic slowdown with four successive rates cuts that have shaved 1.75% off the fed funds rate in as many months have also stoked pricing pressures. The dollar continues to weaken against other currencies, affecting the price of imports. Recent data also shows that oil and food prices, volatile but formidable costs for consumers, were rising at the end of 2007.

"The committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully," the Fed stated.

As has been the case with the rate cuts it has made at its previous three meetings, the action wasn't unanimously supported. It was the latest example of how the Fed's voting members haven't always agreed on the scope or timing of the central bank's rates cuts.

Board member William Poole indicated that he felt the rate cut could have waited until the Fed's regularly scheduled meeting this week.