What are the implications of the Feds lowering of interest rates?
The Fed’s interest rate cuts provide partial relief to financial markets, but they do not provide an economic quick-fix. Certainly, the rate cuts to date have helped facilitate financial adjustment and lowered the probability of a prolonged slump in aggregate demand, but re-establishing normalcy in the money markets will be a gradual process. Moreover, monetary policy affects economic activity with sizeable lags. The lowering of short-term rates — and the expectations of further Fed easing — reduces funding costs, steepens the yield curve, and injects liquidity into the financial system. The Fed’s additional provision of liquidity through its newly established Term Auction Facility may help lower LIBOR rates by supplying liquidity where it is most needed. These actions help lubricate financial markets. But the Fed’s actions are only one component in the process of lifting the subprime mortgage problems, repricing structured credit products, and relaxing bank balance sheet constraints,
