Markets smile on U.S. interest rate cuts

May 2, 2001

Free Market Foundation

Economists who have been criticising the U,S. Federal Reserve and its chairman, Alan Greenspan, for keeping interest rates excessively high had reason to rejoice at yesterday’s surprise cut in rates. They were further cheered by the stock market’s sharp bounce in response.

Critics of the Fed’s recent policies make these points, among others:

The roots of the nation’s economic slowdown can be traced to June 30, 1999 when the Federal Reserve’s Open Market Committee voted to raise the federal funds rate to 5 percent from 4.75.

This was the first of six rounds of monetary tightening – the last of which occurred on May 16, 2000, when the Fed funds rate reached 6.5 percent, its highest level since 1990.

Such increases can take months to affect the economy and we now know that by the fourth quarter of last year growth in real gross domestic product in the U.S. had plummeted to just 1 percent.

The Fed’s initial about-face on interest rates occurred on Jan. 3 of this year when it unexpectedly cut the funds rate by 50 basis points.

More fed funds cuts followed on Jan. 31, March 20, and April 18 – bringing the rate down to its current 4.5 percent.

Between March of last year and February of this year, the total stock market fell by $3.5 trillion and investment in stock equities ground nearly to a halt.

Some economists contend the fall-off in investing was responsible for the decline in economic activity. They don’t blame it on any decline in consumer spending, which actually has risen at a respectable 4.2 percent rate so far this year.

Source: Bruce Bartlett (National Center for Policy Analysis), Can Investor’s Smile Again? Wall Street Journal, April 19, 2001.

For text (WSJ subscribers)

http://interactive.wsj.com/archive/retrieve/data/SB987636970490118827.htm

For more on Federal Reserve Monetary Policy
http://www.ncpa.org/pd/economy/econ6.html