Federal Reserve cutting interest rates

August 18th, 2007

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The US Federal Reserve had announced that they will cut the discount rate by 0.5%. In another statement, they said that

In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

In other words, the Fed is fearing that whatever is happening in the financial side of the economy may spill over into the real side of the economy (see Analysing recent falls in oil prices?real vs investment demand for our explanation of the difference between the real and financial sides of the economy), pushing the US economy into a recession. If this happen, it is possible that a global slowdown will ensue.

Back in March this year, we already expressed our expectation that they will be doing this (see Money printing operations begin). How should we interpret their action? Is the Fed merely taking ?preventive? measure or are they panicking?

Anyway, we believe that Friday’s stock market rally (in the US) is a good opportunity to liquidate any existing holdings of stocks.