On April 30th, the Federal Reserve announced a cut in their main interest rate by 25 basis points, to 2. This is the seventh such cut by the US central bank since the beginning of the credit crunch some eight months ago, totaling 3.25) because of highly inflated energy and food costs. In addition, businesses have continued to feel the pinch of higher secondary costs that affect many other prices, even as output continues to fall. Nevertheless, the strong March activity index from the Institute for Supply Management was still stronger (48.6, with 50 meaning zero growth) than many economists had expected, implying some underlying resilience.
The lingering question remains: what is the Federal Reserve doing by cutting an inter-bank interest rate? It appears now that they are stoking inflation through price distortion, if the positive effects thereof (some stabilization of the troubled financial sector) is ignored. By making dollars cheaper, the value of oil and food is cheapened and necessarily must rise accordingly. Now exchange rates between the dollar and the euro have statistically matched fluctuations in oil prices for 52 for the years between 1999 and 2004. Investors and speculation have turned commodities into a superb place to dump cash, but such simplistic reasoning should be setting off alarms in the wake of the credit crunch.
In Washington and abroad, few have challenged the Fed's decisions, which have not been as noticeably correlated to price increases until recently. That may change as eurozone inflation remains stubbornly above target levels, mostly because the European Central Bank takes energy and food into its purview. While the Fed are still supposed to fight inflation first, their smaller focus means that their culpability is limited. As the election looms over Ben Bernanke's head, he is likely receiving pressure to stabilize first and ask questions later. However, a housing bubble and top-teir mismanagement led to the credit crunch now dragging down global growth. No one is looking to repeat this experience, especially because a commodity bubble is surely the worst kind.
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