The federal funds rate cut: Indiana University faculty comment
Dec. 17, 2008
BLOOMINGTON, Ind. -- The Federal Reserve on Tuesday reduced its benchmark interest rate to a record low level. Faculty members in the Indiana University Kelley School of Business comment on the significance of the rate cut.
Concern with the long term. "What interest rates?" says Charles A. Trzcinka, Finance Department chair in the Kelley School. "It seems there are no short-term, low-risk interest rates."
As a result of the Fed action, Trzcinka adds, "I expect bank accounts to be below 1 percent. But the most interesting question (to me) is, what will be the effect on long-term rates? It could easily raise them. Credit card interest rates at 24 percent indicate that more defaults are expected and there are still inflation concerns. The long term problem with rates this low is inflation, but if we're in a deflationary period, then this is free money -- at least for the short term.
"The other concern," Trzcinka says, "is that rapid rate cuts can cause volatility, and economists keep pointing out that macroeconomic policy needs to be predictable and slowly moving, but what you have here is macro policy that is bouncing all other the place. I'm concerned that monetary policy is changing too quickly for our own good."
Trzcinka can be reached at 812-855-9908 or firstname.lastname@example.org.
No consensus on shoring up confidence. "This policy change intends to inject more liquidity into the system and hopes to impact other interest rates in a downward direction," says Larry Davidson, professor of business economics and public policy at the Kelley School. "This kind of monetary policy is intended to stimulate spending so the economy grows faster.
"This policy was expected by markets for two reasons -- inflation no longer seems to be a worry and the economy is in a recession with no end in sight. Yet more needs to be done. More needs to be done to create confidence in financial institutions to lend money -- and to create confidence among households and business to increase their borrowing and buying. Exactly what should be done is a matter of some difference of opinion. For example, the European Central Bank has been explaining why reducing interest rates to close to zero may not be the correct solution in Europe."
Davidson can be reached at 855-2773 or email@example.com.