Spring 2002
05/14/2002
Question 1.
Consider the following article describing a cut in the Federal Funds rate by the FED in January. For the purpose of this assignment assume that a cut in the Federal Funds rate is equivalent to an increase in the money supply.
A. What is the FED's probable goal in announcing the cut in the Federal Funds Rate?
B. Explain the logic behind their decision.
C. Will the FED succeed? Analyze and describe the probable effects of the FED's action.
Myron Kandel: Fed stuns Wall Street with surprise rate cut
CNN Financial Editor Myron Kandel reports on the surprise rate cut by the Federal Reserve. The Fed cut the Federal Funds rate by a half-percentage point, marking the first time since 1998 the central bank lowered borrowing costs.
Q: Was the size of Wednesday's rate cut a surprise?
KANDEL: The timing and the size of Wednesday's rate cut were a big surprise. A lot of people were thinking the Fed might cut rates before its policymaking meeting on January 31. Some people were saying they might do so after employment numbers were out on Friday.
But nobody was really looking for the rate cut Wednesday. And very few people were looking for a cut of a half percentage point.
KANDEL: Don't forget that the Fed at its previous three meetings did not raise rates. They raised rates six times starting in June of 1998, but they've stood pat in the most recent meetings. In the December meeting, they didn't change rates, but they did change what they call their `bias' from worrying about inflation to worrying about a slowing economy.
The stock market was certainly disappointed that the Fed did not cut rates at the December meeting. And then, as we saw the markets continue to tumble as we got more indications of a slowing economy, the Fed obviously felt the need to cut rates Wednesday.
Q: How did investors react to the announcement?
KANDEL: Investors read this move very favorably. The Dow Jones Industrial Average, which was in the minus column before the Fed announcement came, shot up more than 370 points within an hour after the announcement. The Nasdaq was up 10 percent of its value at one point after the announcement, and that's an amazing increase.
So, it's good news for investors. And the Fed also indicated that it is ready to cut rates again should the need arise.
Q: So, a good New Year's gift for investors after last year's heavy beating?
KANDEL: Yes, especially after the first day of trading of the new year on Tuesday when the market took a big hit.
I think that (Tuesday's tumble) probably was one reason why the Fed was alarmed that things could be getting out of control. And so, they felt the need for a big move, and a big move right away. Lower interest rates are good news for stock market
Question 2:
Read the following article. The FED lowered the Federal Funds rate again in March.
A. Compare and contrast the effect of the March rate cut with the January rate cut.
B. In January and March, the FED did the same thing to the money supply. Will the cut in the Federal Funds rate have similar effects on economic performance? Explain.
Fed lowers key rate half a point
NEW YORK (CNNfn) -- Federal Reserve policy makers Tuesday cut interest rates a half percentage point, hoping the move will give a nudge to a U.S. economy that had dipped to its slowest pace in years.
The move was met with disappointment on Wall Street, where prices dropped in the minutes after the announcement. Many investors had hoped for a three-quarter point cut.
With consumer and business spending slowing, lower interest rates could eventually cut the cost of mortgages, credit card payments and car loans and turn around corporate America's weakening profit outlook.
The Fed policy makers had to deal with a new twist as they considered how big of a cut was needed, as for the first time a big drop in stock prices has coincided with a period of record stock ownership among Americans.
That had many experts arguing whether the central bank should respond to stock market losses that could hurt consumer spending and thus become a bigger-than-ever drag on the economy.
Most economists had predicted a cut of half a percentage point, while others predicted three-quarters of a point. And a few had argued that a cut of a full point was needed to dent a slowdown that began last summer and threatens to end 10 straight years of economic growth, the longest on record in the United States.