Fed Opts to Leave Interest Rates Alone

In a statement, the Federal Open Market Committee (FOMC) acknowledges these pressures and then urged the market to wait for its earlier rate cuts to take affect. "Strains in financial markets have increased significantly and labor markets have weakened further," the FOMC says. "Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters." But over time, says the FOMC, "the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth."

Inflation's uncertain outlook was one reason for the committee's decision, even though it does expect inflation to moderate later this year and next, as Federal Reserve chairman Ben Bernanke said in a speech in August.

The Federal Reserve also opted to keep interest rates at 2% at the end of June; it was a decision that the commercial real estate industry responded to with shrugs, as its main problem was and is the tight debt environment, and not the cost of money.

The FOMC's unanimous non-action on Tuesday, though, was met with more concern, given the events of the last 72 hours. Trimming the interest rate further is the only realistic tool available to the government right now, Brian Bethune, chief US financial economist at Global Insight, told listeners on a conference call Tuesday morning before the Fed announced its decision.

"We are entering the most dangerous phase of this crisis," he said, noting that the economy has weakened even further since July. "In this situation the Fed is like the Marine Corp.--they can come in and deal with the crisis immediately by providing liquidity and reducing rates."

The Fed has injected into the system a significant amount of liquidity over the last couple of days, he acknowledged. "But in the end we think the Fed needs to move to reduce rates" by another 50 basis points.

Inflation was an "overblown" issue "very much connected to the spike in energy prices," he also said. Now "there is no need to be concerned about pipeline inflation risk." Furthermore, Global Insight's chief US economist Nigel Gault said on the same call, oil prices are now declining--a clear plus--but this decline will only partially offset the current economic troubles.

Not surprisingly, there were varying reactions to the Fed's decision, largely coalescing around two schools of thought: one, epitomized by Bethune; the second, calling for the monetary authority to be conservative with one of the few inflation-fighting tools it has at its disposal.

Also, the new measures the Fed announced it would take to inject more liquidity into the system--as well as similar moves by other world central banks--is a more powerful action than an interest rate cut, Seth Weinstein, principal of Stamford, CT-based Hannah Real Estate Investors, tells GlobeSt.com. "The system is being flooded with cash as Central Banks, including the Fed, make tens of billions of dollars available to banks to lend," he says.

On Monday the Federal Reserve Bank announced it would expand its lending program as well as accept a wider range of collateral for loans. Since then, the European Central Bank, the Swiss National Bank, the Reserve Bank of Australia and China's Central Bank, have all made various moves to inject liquidity into the global financial network.