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Fed Plots Measured Course

Given that the discount window is "rarely used" and most debt obligations are tied to the fed funds rate,"the cut in the discount rate will impart almost no direct benefit on the U.S. economy," writes Tony Crescenzi, chief fixed-income economist at Miller Tabak and contributor. That "is why it is imperative that the Fed validate this largely symbolic but important action with a cut in the fed funds rate."

Thus far, the discount window has not been excessively used. James Bianco of Bianco Research notes that discount-window borrowings were reported at $271 million for the week ended Aug. 15, up from $251 million the week ended Aug 8. "These are fairly typical numbers," Bianco says. "Therefore, no one that is in trouble has borrowed from the discount window" -- at least not prior to Friday morning's discount rate cut, notwithstanding hysterical cries of economic Armageddon from various talking heads.

Meanwhile, the risks to inflation that have kept the Fed on hold for a year are still in place. Headline inflation is still high, and labor costs have been rising. More importantly, aggressive rate cuts could further deteriorate the value of the dollar, which was recently down modestly vs. the yen and more significantly vs. the euro in response to Friday's Fed action.

A weaker dollar raises the risk of the U.S. importing inflation, which could mean aggressive rate hikes when this storm is over sometime in the next year or so. Michael Darda, chief economist at MKM Partners, recalls that after the Fed's aggressive cuts in response to the October 1987 market crash, the economy endured a four-year period of higher core inflation.

Lastly, the Fed also does not want to bail out the lenders who were overaggressive in lending in the first place. That's not to say they don't care about the public or people hurt by higher rates. The people whose homes were foreclosed on may not benefit from a fed funds rate cut right now as much as they'd suffer under an economy buried by a weak dollar and higher inflation.

Aaron L. Task is editor at large of In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback; click here to send him an email.

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