The title is pretty eloquent. Enough is said to reflect on the possible outcomes of this ‘modest’ monetary policy action as some of the stock market brokers saw it after they heard Mr. Bernanke’s afternoon announcement.
The FED apparently fears a serious slowdown of the US economy (which would naturally cause a slowdown in the whole world) because of the looming credit crunch, the sudden depreciation of the prices on the US real estate market and the decrease in aggregate spending of both consumers and business decision-makers.
I am sure that the FED realizes they are in a ’sticky’ situation between the threat of economic contraction and the rising threat of inflation. If we put aside for a moment the strictly domestic problems of the US economy and focus on the international picture, more serious problems emerge. There is the depreciating dollar (which fortunately stood firm today and in fact appreciated slightly, possibly because of the new monetary policy moves) which will definitely be affected to a lesser or greater degree by the change in interest rates. The problem here is that the loan made in US dollars becomes cheaper with a whole percent than several months ago (on theory). Therefore, if the rest of the major national reserve banks in Europe and East Asia do not lower their interest rates, the new monetary policy, as of today, will possibly drive down the US currency even more. That of course, should be prevented by a efficient cooperation between the central bankers worldwide and nobody doubts that collective efforts will be made to marginalize the losses from the crisis.
On the other hand, we have the problem of inflation. Driven up by dramatic rise in price of oil to a new record high and energy prices as a whole, plus a rise in crop prices. These factors combined can cause serious inflation to spread in other sectors soon and would not be forgotten by the US policy makers.
Moving to the other side of the world, to China, we see that the Chinese also face with high oil prices and in fact oil shortages caused by less efficient artificially controlled environment (the government prefers to have low oil prices instead of adequate oil supply). Today, China is seriously threatened by all-sector inflation cause by the rise in price of oil. On the other hand, China faces a dollar depreciating against its own ‘Yuan’ which is not good for the country because it looses its advantage of a lower Yuan to widen a gap of a foreign debt for the USA. Therefore, recent events are anything but profitable for China. Moreover, people should remember how the dollar emerged as the British pound sterling of the Post-WWII world through Breton Woods II.
In conclusion, we should say that the FED made a big mistake with their fresh announcement. The Open Market Committee probably underestimated the psychological effects of the news coming from their meetings because this time no clear signals about inflation or growth were given and the business community is confused. Apparently, business decision-making should use its intuition and it seems that the FED left the community partly on its own this time.
