In an attempt to revamp the declining economy, the Federal Reserve announced another cut in the Federal Funds Rate last week, which could eventually be detrimental to the stock market and exchange traded funds (ETFs).
In general, a cut in interest rates is beneficial to reviving a downward spiraling economy because of faster reactions to monetary policy changes than fiscal policy changes. However, this time that just might not be the case. The most recent rate cut puts the interest rate pretty close to nil, which often causes a liquidity trap, meaning that people would rather hold cash than make loans, states Perry Sadorsky of Seeking Alpha.
This isn’t the first time that abnormally low interest rates have been seen. They occurred in the United States in the 1930s and in Japan during the late 1990s. What is different about this time is that the cuts have been introduced in a relatively short time frame, the first starting in September of 2007, as compared to the Japanese who took about five years to make such drastic changes.
So far, it seems like these rate cuts have not done much to change the U.S. economy, in part because they only works if consumers have the money and confidence to respond. The problem here is that either the low interest rates are not being passed on to consumers or consumer confidence is at the bottom of the barrel making borrowing money less attractive.
So, what else can the Fed do, with interest rates nearly as low as they can go? Jeremy Siegel, the senior investment strategy advisor for WisdomTree, suggests five things:
- Rebase LIBOR to the Fed Funds rate instead of European rates;
- Back up interbank borrowing;
- Guarantee private lending, including commercial paper and lines of credit (including credit cards);
- Make sure that the banks that have received TARP funds aren’t allowed to cut lines of credit – consumers have been worried about this;
- The Fed can buy stock index futures
If this most recent rate cut doesn’t do anything, Siegel’s recommendations should be considered.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.