No surprises from Ben Bernanke today, although the end result is pretty overwhelming. The Federal Reserve lowered the target on the Fed funds rate to a range of zero to 0.25% … call it free money.
What's it mean for the economy? Two things: One, the Fed is making money about as easy to come by as it ever has, and two, it can't make it any easier going forward. Bernanke's spent the past year and a half firing as many bullets as possible to prop up the economy, and he's finally out of ammunition. With a fed funds rate at effectively zero, there're few traditional tools he can use to get things moving again.
I say "traditional" because Bernanke seems to want to pull a few more tricks out of his sleeve. One tool is the direct purchase of Freddie Mac (NYSE:FRE) and Fannie Mae (NYSE:FNM) securities in an attempt to lower borrowing costs for home owners; another is the Federal Reserve floating its own debt to inject more money into the economy. Both are ad hoc, untested, unparalleled, and should probably scare you silly.
There are a few conflicting arguments surrounding these moves.
One is that with the economy as weak as it is today, the Fed should do everything it can to get money in consumers' pockets to get them spending again. In a vacuum, that probably makes sense, but when you consider that too much spending and too much easy credit is partially what got us into this mess, it seems pretty paradoxical.
The other argument against cutting rates to zero is the danger that we'll enter a "liquidity trap," which is essentially what happens when consumers come to expect deflation and hoard money rather than spend it. When this happens, deflation feeds on itself, but since the Fed has already cut rates as far as possible, there's nothing it can do … there are no more tools to get the economy moving again. Again, Bernanke's out of bullets.
The flip side of the liquidity trap is what happens when the economy inevitably begins to reinflate on its own. One factor that could spawn this is the weakening of the dollar, which we saw firsthand today as soon as news from the Fed came out. The Fed can, in theory, pull liquidity out of the economy before inflation begins to spiral skyward, but come on -- its history of being Johnny-on-the-spot isn't too impressive.
Winners of this free-money giveaway are obviously banks. Not surprisingly, Citigroup (NYSE:C), Wells Fargo (NYSE:WFC), and Morgan Stanley (NYSE:MS) were all up double-digit percentages on the news.
Well, another day, another history-making event. How do you feel about the Fed essentially lending money for nothing? Fire your thoughts away in the comment section below.
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