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"How much will the Fed cut?".

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Introduction

I.B. Economics Commentary 2 By: Vanja Ivancevic Article: "How much will the Fed cut?", Justin Lahart, CNN/Money Due to a weakening in the economy and in effect, an increase in the unemployment rate from 5.6% to 5.7%, the Federal Reserve Policy makers have to decide on how much to cut interest rates in order to strengthen the economy again and improve the current situation. Although the cut itself is almost ensured to be put into action, there is some debate and questioning over whether the cut will be one of a quarter-percentage or a half-percentage. In the monthly job reports it was clear that a further 5000 jobs were lost in the U.S.A during October and that the unemployment rate is increasing. Challenger Gray & Christmas stated that job cut announcements were at their peak in November 2002 since January 2001, and that the Fed was to come up with a solution to ensure that the economy does not continue to collapse in this direction. The Federal bank will have to act and deliberately change the interest rates in order to affect the economy positively again. Since interest rates affect spending on durable goods, investment spending and saving, changes that are made to interest rates will have a direct affect on the aggregate demand. ...read more.

Middle

Economic data have shown the economy continued to weaken last month, virtually ensuring that the Fed will cut. Last Friday, the monthly jobs report showed that the U.S. lost another 5000 jobs in October while the unemployment rate crept up to 5.7 percent from September's 5.6 percent. The Institute of Supply Management's Purchasing Managers' Index fell one point to 48.5, indicating that the manufacturing economy continued to contract. Monday, Challenger Gray & Christmas reported that job-cut announcements jumped to their highest level since January last month. Market expectations are for the Fed to cut by just a quarter-percentage point Wednesday. Fed-funds futures -- monthly futures contracts that indicate how traders are betting the Fed will act -- have priced in a quarter-point cut, but show only a slight chance of a half-point rate drop. Some economists disagree with that assessment. "Why screw around? If they're going to cut, they'll go a half-point," said Diane Swonk, chief economist at Bank One. "They're just not in a position to be taking risks." Swonk feels the economy has the wherewithal to muddle its way through to recovery, but believes that the danger posed by a double-dip recession still needs to be taken seriously. Moreover, with the threat of inflation off the radar screen, there's not the same kind of risk of easing by too much as there was in the past. ...read more.

Conclusion

There are reasons the market is betting on a quarter-point cut instead of a half-point one. "The best tack is to move by a quarter point, with the promise that there will be more cuts to come if the economy remains weak," said Lehman Brothers economist Ethan Harris. "You can't maintain that promise with big bulky rate cuts." Moreover, thinks Miller Tabak bond market strategist Tony Crescenzi, the economy simply hasn't shown the sort of weakness yet that would prompt the Fed to move aggressively. "The Fed's theme has been that this is only a bump along the road to recovery, and they can't smooth every bump," he said. Crescenzi thinks that one of the big reasons for cutting by a half point -- to help give support to the equity market -- just doesn't make sense. The Fed's 11 cuts last year didn't do much for stocks. "Why do something that has only a short-term effect on the market?," he said. "It's wasteful." For that matter, why cut at all? If dropping the funds rate from 6.5 percent to 1.75 percent didn't do anything, what's another half point? "Because it's better than doing nothing," said Dudley. "A wild boar charges you and you shoot four of the six shots in your gun at it and it doesn't fall. Do you look at your gun philosophically and think, the first four shots didn't work, why bother?" 1 http://www.bized.ac.uk/glossary/big/ad_inc.gif ...read more.

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