There are a couple reasons for this, its an effort to help stimulate the economy and ease liquidity in the credit markets, but it is also to guard against deflation. What about the concern of inflation after cutting the rates so low? Do we want inflation? Yes, I feel there is a real threat of a deflationary spiral that needs to be hedged and thus the feds are making moves to start buying back treasuries putting more money in the market and the latest rate cut is to counter act this devastating effect..In this article(http://www.bloomberg.com/apps/news?pid=20601087&sid=aLj4INeKlU3M&refer=home)
it shows that there was an immediate response from the rate cut that was most likely predicted and hoped for by our feds, essentially hoping that the drop in the dollar will create inflation by making it more expensive to get foreign products. This also works in trying to keep business in the US, countries will look to buy our products becuase they are cheaper, and citizens will look to buying more US products aswell since it will come at a lower cost.
Here is the most recent CPI as of 12/17/2008
Notice the abnormal drop in consumer products over the past 4 months, much steeper then anything we have seen for the last 10 years according to this chart.
CPIhttp://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=CUUR0000SA0&output_view=pct_1mth
So what is a Deflationary Spiral? See below pulled from wikipedia.com
http://en.wikipedia.org/wiki/Deflation
Deflationary Spiral
A deflationary spiral is a situation where decreases in price lead to lower production, which in turn leads to lower wages and demand, which leads to further decreases in price. Since reductions in general price level are called deflation, a deflationary spiral is when reductions in price lead to a vicious circle, where a problem exacerbates its own cause. The Great Depression was regarded as a deflationary spiral.
A deflationary spiral is the modern macroeconomic version of the general glut controversy of the 19Th century.
Counteracting deflation Until the 1930s, it was commonly believed by economists that deflation would cure itself. As prices decreased, demand would naturally increase and the economic system would correct itself without outside intervention.
This view was challenged in the 1930s during the Great Depression. Keynesian theory argued that the economic system was not self correcting with respect to deflation and that governments and central banks had to take active measures to boost demand through tax cuts or increases in government spending. Reserve requirements from the central bank were high and the central bank could then have effectively increased money supply by simply reducing the reserve requirements and through "open" market operations (e.g., buying treasury bonds for cash) to offset the reduction of money supply in the private sectors due to the collapse of credit (credit is a form of money).
With the rise of monetarist ideas, the focus in fighting deflation was put on expanding demand by lowering interest rates (i.e., reducing the "cost" of money). This view has received a setback in light of the failure of accommodating policies in both Japan and the US to spur demand after stock market shocks in the early 1990s and in 2000 - 2002, respectively. Economists now worry about the (inflationary) impact of monetary policies on asset prices. Sustained low real rates can be the direct cause of higher asset prices and excessive debt accumulation. Therefore lowering rates may prove only a temporary palliative, leading to the aggravation of an eventual future debt deflation crisis.
Obviously... If we get past the deflationary spiral scare... because of all the money that is going into the market the next fear is of an inflation or hyperinflation stage, which is what happened to post World War 2 Germany... Folks where bringing wheel barrels to stores full of money to buy bread.
Hopefully our economy can recover before this happens. I guess the feds are addressing the issues as they come. I prefer being a fiscal conservative, small government and little involvement. Indeed a cut was needed, but cutting the rate as low as it did is concerning. With this extremely large government that has bend spend happy over the past 8 years (very Democratic like), this could doom the US into a lengthy and difficult depression, that is possible if this economy does not get under control. Lowering taxes and shrinking government spending is most likely going to be necessary in order to cope.
I think Obama is smart and sees this as he has already said he has frozen any of his plans to raise taxes in the next 2 years. I like this approach, taxes are already low for most, lets keep it that way and try leaving as much money in the economy as we can for now. Then within the next two years if there is an inflation scare they have the ability to raise taxes slightly and raise rates in order to take money out of the system and thus re-balance our economy. Again this is only going to work if the government learns to control spending and shrink!!!
Isn't this strange, we had eight years with a "so called" republican (conservative) president, that spent money and acted more like a democrat. Now we have a democrat admin coming into office and in order to help this economy recover he has to act more like a conservative! Looking at his actions speak to this, all his actions in the transition period are showing a different Obama then the campaign Obama. He has backed off most of his "Change Policies" and has been going through all the books in the government looking at budgit, getting ready to shrink government, sweetness! Score for the fiscal conservatives! I did not vote for Obama, not because I did not think he would be the better president, as I feel he will be. I was concerned of having a democratic president and a democratic congress. This feels wrong to me, as the founding fathers themselves wrote a document that was heavy on "checks and balances". I was also concerned with his tax policies in this economic times and his possible spending habbits being a democrat. I guess time will only tell how good of a president he will be...
I didn't vote for McCain either, I couldn't bring myself to vote for him, his VP pick was aweful and his policies resembled too closely to the Bush admin policies, I voted for Ron Paul.
What is Hyper Inflation?
http://en.wikipedia.org/wiki/Hyperinflation
In economics, hyperinflation is inflation that is "out of control", a condition in which prices increase rapidly as a currency loses its value. Formal definitions vary from a cumulative inflation rate over three years approaching 100% to "inflation exceeding 50% a month." In informal usage the term is often applied to much lower rates. As a rule of thumb, normal inflation is reported per year, but hyperinflation is often reported for much shorter intervals, often per month.
The definition used by most economists is "an inflationary cycle without any tendency toward equilibrium." A vicious circle is created in which more and more inflation is created with each iteration of the cycle. Although there is a great deal of debate about the root causes of hyperinflation, it becomes visible when there is an unchecked increase in the money supply (or drastic debasement of coinage) usually accompanied by a widespread unwillingness to hold the money for more than the time needed to trade it for something tangible to avoid further loss. Hyperinflation is often associated with wars (or their aftermath), economic depressions, and political or social upheavals.
