Fed slashes interest rates to zero

Dec.16, 2008 10:30 p.m.

The US Federal Reserve and its chairman Ben Bernanke have shown that they understand very well the position that the American economy is in and the urgency of both monetary and fiscal stimulation.They have adopted a target interest rate of between 0 and 1/4 of a per cent for the federal funds rate in an effort to stimulate the economy and get the banks loaning money again. The Chairman has also promised further measures if needed including the Fed purchasing both public and private securities. This is a very intelligent approach which ought to inject further liquidity and lower the Libor rate as well as restore confidence to the banking sector. Coupled with the massive stimulus package that the Obama administration will introduce in January and the efforts of the Bush administration earlier in the year there will be a significant recovery sooner than would be the case in the absence of these measures.This recovery will be aided by comparable stimulus policies in other major economies around the globe.So long as inflation rates keep falling, the US consumer price index fell by 1.7 % this past month and over 3.05 over the past three months the largest   drop since the early 1930s. These policies are absolutely essential and will not in the short or even medium term of two years cause inflation as opposed to reflation and the reversal of deflation.

Later the Fed will likely have to anticipate that the vector forces will transfer from restoring output to pushing prices and then take the appropriate steps to withdraw much of the stimulus once a stable path to growth and lower unemployment has been re-established. Today the markets liked the Fed's actions. We shall see if this persists in the days ahead. But there is no doubt that the Fed and Bernanke have correctly diagnosed the problem and prescribed appropriate remedies.