Thursday, September 6, 2007

Why the Federal Reserve Should NOT cut the interest rate

A lot of people are pushing for the Federal Reserve to cut the interest rate in response to the problems in the sub-prime loan industry, lender want the cut in order to easy the burden of loan defaults and some in the financial sector want it to push up the values of their investments, but its my belief that cutting the interest rate at this point would be the wrong thing to do. The first reason is that the interest rate should only be change by the Federal Reserve in order to respond to changes in the economy as whole, the sub-prime loan problems are not a broad based economic problem, in real terms its only affected the still relatively small amount of home owners that are defaulting on their loans, the financial institutions that hold those loans or have invested in them, and home construction and retail industry, both of which are coming off a multi year boom that has left many housing markets in the United States over valued and correction is now need to return those houses to there true non-market bubble price. Yes the effects have spilled over into the larger stock market and depressed stock prices, including many companies that will not be directly affected by the sub-prime loan market, but as investor confidence recovers and the bad companies are sorted out from the good, there prices will recover, and until then this creates a buying opportunity for investment how will have the chance to buy stock in good companies that have been over sold and now over valued.

There is nothing fundamental wrong with the United State economy, growth in the second quarter was about 4 percent, which is very strong, and while it expected to be weaker for the rest of the year, there is no signs of recession, and expected growth is still expected to be stronger than growth in the Euro Zone, and a long with that the manufacturing sector in the US is doing well, productivity is growing, our productivity is the highest in the world, and unemployment is low.

The second reason is that cutting the interest rate at the moment would send the wrong signal to companies that engaged in making risky loans, encouraging them to continue making these loans expecting government intervention if they turn bad on them. The government needs to stay out and let the market work the problem, in the long run it will be best for everyone.

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