Fed Policy: Is There Room For A Lower Federal Funds Rate?

The effective federal funds rate on November 13 was 0.35%. Monetary policy will be tight if the effective federal funds rate returns close to the target federal funds rate.

The effective federal funds rate continues to trade far below the target federal funds rate of 1.00% (see chart 1). The effective federal funds rate on November 13 was 0.35%. Monetary policy will be tight if the effective federal funds rate returns close to the target federal funds rate. In other words, in recent days the large discrepancy between the effective rate and target federal funds rate has resulted in monetary policy being easier that what the target federal funds rate has implied. Therefore, it appears that there may not be room for further easing of monetary policy. Furthermore, the benefit from a lower federal funds rate is not clear.

 

Bank of England Forecasts Worsening Recession

 

The Bank of England’s Quarterly Inflation Report was released this week and its outlook for the UK economy was every bit as dismal as feared. The Bank’s central projections for GDP growth and inflation are “substantially weaker” than in the August Report, although the November Report also acknowledges that the prospects for both are “unusually uncertain.” The central projection is for a pronounced contraction in domestic demand that causes output to fall markedly through the first half of 2009, with the contraction in real GDP reaching around 2.0% on the year by Q2. Assuming a combination of lower interest rates, a gradual expansion in credit, lower global commodity prices, a weaker currency, and continued fiscal stimulus, a gradual recovery should get underway in the second half of next year, with real GDP growth nudging back into positive territory by Q1 2010.

 

The annual rate of inflation is projected to fall sharply in the near term, down from 5.2% in September to around 2.0% by Q2 next year, and then “well below the 2.0% target” by mid-2010. The Report also noted that most measures of inflation expectations have fallen back in recent months. This year’s previous Reports had highlighted the possibility of rising inflation expectations as a key risk to the inflation outlook.

 

All told, the BoE’s projections are its most pessimistic in over a decade and are significantly worse than just three months ago. Back in August, the BoE’s central projection saw the economy bottoming out in Q2 2009 with real GDP growth around zero y-o-y, and inflation not falling below the target rate until early 2011.
In his subsequent press conference, BoE Governor Mervyn King noted that there will be “much to learn between now and our next meeting” but also stated that “we are certainly prepared to cut the Bank rate again, if that proves to be necessary.

 

This week also brought the release of September employment data. The number of unemployed (EU-harmonized ILO measure) jumped to 1.825 million in the three months to September, the highest level since October-December 1997, pushing the unemployment rate up to 5.8%, the highest rate since January-March 2000. The number of people claiming unemployment benefit (“claimant count unemployment”) jumped by 36,500 in October, the sharpest increase since December 1992.

 

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