Tuesday, January 22, 2008

Just How Worried is the Fed?

During times of credit crisis and threatened economic slowdown, reductions by the Federal Reserve in the discount rate help to stimulate economic activity by enabling commercial banks to borrow money at a favorable rate. This aids the profitability of banks and encourages loan activity, which makes money more widely available to the economy and stimulates economic activity. The Fed does not necessarily reduce the discount rate all at once; rather, cuts may come in stages as economic data roll in. If the data are ominous and the Fed is particularly worried about deflation, recession, and/or credit crises, we can expect sizable cuts in the discount rate over time. For that reason, changes in the discount rate might be viewed as an indicator of Fed sentiment: the degree to which the Fed is worried about economic slowdown (leading to aggressive discount rate cutting) or overheating (leading to aggressive discount rate hiking).

So how worried is the current Fed, based on historical norms for discount rate cuts? I went back to 1965 (2248 weeks of data) and examined the rate of change for the discount rate over moving 26-week periods.

Interestingly, we're currently seeing a 36% drop in the discount rate over the latest 26-week period. Only one other period since 1965 has seen such aggressive discount rate cutting--and that was the 2001-2002 recession. (We saw a 45% drop in the discount rate during late 2001 and a 42% drop during early 2002).

Other periods of Fed worry and 26-week discount rate declines have been:

* Late 1991/Early 1992 - Down 28%
* Late 1982/Early 1983 - Down 26%
* August 1986 - Down 22%
* May 1975 - Down 21%
* August/September, 1980 - Down 21%
* May/June 1991 - Down 18%
* February-May 1971 - Down 17%
* May/June 1992 - Down 17%

Note that the vast majority of these time periods ended up being good times to buy stocks for longer-term positions. Interestingly, however, the extensive rate cutting by the Fed during the 2001-2002 period is now being blamed for the housing bubble and credit recklessness that ensued. Given that we are now seeing Fed worry (and discount rate cutting) of similar proportions, we can only speculate as to the bubbles that could arise from the latest rate actions.


Anatrader said...


The FED rate cut of 75 basis points has been seen as a reaction to the markets rather than to long term economic problems.

Still, it is a temporary measure to halt the waterfall declines we have been seeing in the markets lately.

rc said...

Thanks for your amazingly insightful and useful blog, Dr. Brett! I dont recall the exact citation right now, but I believe that there is some recent research that suggests sharp interest rate cuts early in a downturn can help to shorten the length of a looming recession. This new understanding could result in fed behavior that may look more fearful by older standards of behavior, skewing your historical comparison.

Brandon Wilhite said...

Dr. Brett,

I actually find this encouraging, from the standpoint that rapid declines have happened more than a few times (albeit this one is larger than most). I also find the virtual non-movement of USD to this news yesterday encouraging. It still remains to be seen really, but perhaps USD won't get beat-up too bad over these new cuts. If so, coupled with a few other observations, this would almost seem like the beginning of a regime change in the currencies. I don't have nearly enough experience to be certain of that though.

A question: Is there a place I can get past rate decisions and/or economic data in table form, or consolidated in some way? I haven't been able to find it when I've looked in the past.


jm99 said...

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I was also pleased to read your comments regarding your site traffic increasing during times of uncertainty. This has been my observation also and I’m sure its possible to construct a very profitable contrarian system based on this data.

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Anatrader said...

Brett & Brandon

Try this site:


Charles said...


The Federal Reserve Bank of St. Louis issues economic data. You will have to search around the web site, but most of the data is either in chart or table form.



Brandon Wilhite said...


Thanks. I know I've looked at that site before, but it's such a big mess I think I gave up! Anyway, the more specific site needed is:


To query the interest rates in particular, it appears to be:


The next step for me, would be to find this data for other countries...it seems like few of them make it easy. I've looked for this data before, but think I'm ready now for a serious search.

Thanks a bunch.


Brandon Wilhite said...

Sorry...the target rate is found here:


Josh Ulrich said...

Dr. Brett,

My understanding is that the discount window is seldom used because it is seen as a sign of desperation by the borrowing institution, since the discount rate is usually 25-50 bps higher than the Fed Funds rate.

What are your thoughts?

Brett Steenbarger, Ph.D. said...

Thanks rc,

Great point: Fed behavior may change as a function of research and experience--


Brett Steenbarger, Ph.D. said...

Hi Brandon,

I'm not aware of any source for the data as you describe, but will keep an eye out--


Brett Steenbarger, Ph.D. said...

Hi Josh,

Yes, the window is kind of a mechanism of last resort, so the need to ease aggressively can be seen as a perceived need to make this avenue more attractive--