The question for the Fed: Will further rate cuts help or hurt the credit crisis?
The Fed has been cutting to support the financial sector, and address risks (as they see them) of financial sector issues spilling over to the real sector.
How does the Fed see rate cuts helping the financial sector?
Lower payments for borrowers assist in servicing/refinancing outstanding debt and facilitate continued ‘borrowing to spend.’
However, in this cycle, it seems that rate cuts have been instrumental in the USD decline that correlates with rising gasoline/food/import prices.
‘Well anchored’ wages mean consumers are spending more on food/energy and have less for other goods and services.
And less for debt service, as evidenced by rising delinquencies and the (still mainly subprime, but starting to spread) deteriorating credit quality of consumer loan portfolios.
Yes, exports are increasing dramatically, supporting GDP, keeping the output gap reasonably low, but not increasing income for debt service where that is needed.
So the question for the Fed is, on balance, will further rate cuts help or hurt the credit crisis?
Will further cuts ‘ease financial conditions’ via interest rate channels?
Or will further cuts ‘tighten financial conditions’ via the current fx/inflation/debt service income channel?
And, even if those potential outcomes for the credit crisis are approximately equal, does the nod go to not cutting for reasons of residual inflation issues?
So far, not a single ‘real economy’ company has had problems beyond a slowdown in earnings and concern over future earnings. And slowdowns in sales have all been related to consumers being hurt by higher food and energy prices.
This implies the falling dollar/higher import prices is what has hurt the companies that have been subject to consumer weakness.
This implies Fed policy designed to protect the real economy from from potential spillover from the financial sector crisis has, as a side effect, done direct damage to the real economy.
And, of course, this is only relevant for the Fed if it comes up for discussion at the meeting on Tuesday.
Close friends tell me it probably won’t.