The US government and Federal Reserve have responded aggressively to combat recession concerns that stem from ongoing housing and mortgage… … struggles and new concerns over a tightening service sector and slowing business growth.

The combined 1.25% Fed rate cuts the last week of January, brought the Fed fund rate to 3%. While it will take some time for the market to be impacted by the cuts, two leading Federal Reserve officials have suggested the moves may lead to inflation challenges.

The rate cuts are intended to provide cheaper borrowing rates for consumers and business, which should help stimulate business growth and consumer spending. The idea is to give business affordable capital to expand and provide greater benefits to consumers, while simultaneously helping consumers spend more freely due to reduced costs of credit.

Federal Reserve Bank of Dallas President Richard Fisher today (February 7) echoed concerns expressed yesterday by Federal Reserve Bank of Philadelphia President Charles Plosser, regarding inflation. The difference between Fisher and Plosser is that Fisher voted against the January 30th half point rate cut, while Plosser voted for it.

Plosser believed the rate cut was necessary to help return the economy back to an upward trend of 2.7% growth next year, in spite of potential inflation issues. He called on the Central Bank to closely monitor the impact of the recent moves. Fisher voted against the last cut and believes inflation is of extreme concern. He suggested the moves prior to the January 30th cut were enough to help reduce downside economic risk.

Recent data supports the notion that inflation remains a big concern for the US economy. Fisher believes high demand for food, energy, and other commodities are causing upward price movement and continued inflationary risk. The Fed core inflation gauge (excludes food and energy) rose 2.2% from December 2006 to December 2007. This suggests high price movement in key areas.

Rate cuts are a balancing act for the Fed. They must walk a fine line. The goal of cuts is to stimulate the economy and avoid recession. The challenge is that rate cuts can influence price movement in sectors that directly impact consumers, such as at the gasoline pump and in the grocery store. The thought of higher prices on top of already relatively high prices scares consumers.

Some economists and many investors are betting consumer demand for energy will drop. Oil futures fell below $89 per barrel yesterday and surveys indicate expectations for lower energy demand. While this may result in lower short-term consumer prices, with the busy summer travel season around the corner, $3.50 average gasoline prices are widely anticipated.

In spite of concerns from Fisher and Plosser about inflation, US analysts are generally forecasting at least another one percent drop in the Fed rate, to a low of two percent. High inflation data in key consumer markets might derail such a move, but many Central Bank members seem resigned to the fact that moderate inflation is inevitable in 2008, and economic growth must remain in focus.

The Senate Thursday passed the economic stimulus package approved by the House last week, which should help get tax rebates to millions of Americans by May or June. The bill was debated for about a week as both parties looked to add or subtract from the House version of the bill. Republicans agreed to a compromise that adds rebates for older people and disabled veterans, but leaves out additional benefits for the unemployed, poor, and some industries. It is hoped that President Bush could sign the bill Thursday night or Friday, expediting the process of getting rebates to consumers.

The $161 billion economic stimulus and tax rebate package should ease a bit of the pressure on the Central Bank to stimulate the economy with deep interest cuts. It is still widely expected that additional cuts will come.

Market Recap

US equities extended their decline Wednesday, with the Dow falling 65 points and the NASDAQ off by 30. Macy’s announced they’ll be cutting 2,300 jobs. A report showed worker productivity has dropped significantly. Two prominent Federal Reserve officials suggested inflation concerns may affect the prospect of further rate cuts. Stocks made modest gains Thursday of 46 points in the Dow, 14 points in the NASDAQ, and 10 in the S&P. The big news late Thursday was the passing of the tax rebate stimulus plan by the Senate. President Bush is expected to sign the bill tonight or tomorrow. Jobless claims fell last week and retail stores had a disappointing January.

Neil Kokemuller
Thursday, February 5, 2008
6:08 PM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA. He has a MBA from Iowa State University with a specialization in marketing.

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