169 The fact that the Fed may cut represents a lightening-fast change in the outlook for interest rates. Only last Friday, almost all economists saw the Fed remaining on hold at 2% with the next move being a rate hike. But the stress in financial markets has changed all of that. Late on Sunday night, Lehman Brothers announced that efforts to find a partner failed and the company would file for bankruptcy. In addition, Bank of America announced that it would acquire Merrill Lynch. The events raised the possibility of concerted rate cuts from the Fed, the European Central Bank and the Bank of Japan, economists at Morgan Stanley told clients. "A precondition for such action would be disorderly markets," the Morgan Stanley economists wrote in a note to clients. Fears that the collapse of Lehman Brothers could cause worried banks to freeze lending to each other and customers prompted the Fed, the ECB and the Bank of England to aggressively add liquidity to money markets Monday. Maury Harris, chief economist at UBS, was one of the few economists expecting a rate cut by the Fed before the end of the year. But Harris was skeptical that the Fed would cut at its meeting on Tuesday. Rather, he said, the Fed would issue a statement leaning in the direction of lower rates. "There likely will be reluctance at this point for Fed officials to quickly cut the funds rate in response to the market turmoil," Harris said. Many Fed policy makers have been anxious for the Fed to tighten monetary policy, believing that low 2% rate was fueling the public's expectations of higher inflation. But the majority of Fed members have been reluctant to move rates higher. Victor Li, associate professor of economics at the Villanova School of Business, said that a rate cut might be counterproductive.
Villanova School of Business 2008 Media Report