The Federal Reserve Cuts 3/4 percent or 0.75%

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The Federal Reserve has called in an unscheduled 0.75% interest rate cut.  Why did they do this?  There was a really big global sell off yesterday into today outside of the US and when the market opened today in New York, the DOW as well as the other various indexes were down 5%.  There was fear that the DOW would drop 1000 points today which is roughly 7-8% of the market value.

Are we in a recession?  In macroeconomic theory, a recession is defined as a decline in the Gross Domestic Product for 2 or more quarters in a year.  This is a little confusion for lay persons like me and you so I like to think of it as a drop in 20% of the stock market index.  The index that most people rely on as a reflection of the market in general is the S&P 500 but the one that everyone thinks about is the DOW which is an aggregate of 30 of the largest companies in the US.  A 10% drop in the market is generally considered a correction.  We are definitely in recession territory right now based on this definition.  I think that is the reason why the government is currently so concerned that Bush announced just recently that we will get an economic stimulus package of 150 billion dollars.  This would be in the form of tax rebates but it is not specific as to how and by how much it will be applied to individuals versus businesses.  Some speculate that it will equate to about 800 dollars per individual.  What it does mean is that the stimulus package will equal 1% of the US Gross Domestic Product.

Will this be enough?  Some economic strategists believe that it is small of a package and just a drop in a big bucket.  Nevertheless, it did nothing to change the outcome of the market friday.  With the big market selloff that happened globally, the Fed also reacted with a drop in the overnight lending interest rate to 3.5 percent from 4.25 percent.  I like to think of the fed rate cut as Lantus or Glargine insulin with a short term fix and hopefully the stimulus package as stanard insulin or NPH hopefully helping to take effect in the next few weeks to months if at all.

What will be the short term reactions to this action?

1. the value of the dollar will drop
2. gold prices will continue to increase
3. imported goods prices will rise
4. foreign investors will invest more in the US
5. gasoline prices will rise
6. it probably won’t affect student loans
7. inflation concerns will be a serious issue in the near future.

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