Has the Fed gone too far?

Ben Bernanke & Co. are likely to keep rates steady. But some argue the economy is worse off because cuts already have gone too far.

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By Chris Isidore, CNNMoney.com senior writer

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NEW YORK (CNNMoney.com) -- Wall Street thinks the Federal Reserve is almost certainly done cutting interest rates for the time being.

But as inflation fears rattle Wall Street, some economists are beginning to wonder if the Fed went too far by cutting rates as much as it did in such a short period of time.

The central bank is widely expected to leave its key federal funds rate at 2% after it concludes its two-day meeting Wednesday. That would be the first time the Fed left rates steady following seven rate cuts since last September.

The fed funds rate is the central bank's key lever to spur economic growth or slow it in an effort to keep prices in check. It is used as a benchmark to set rates paid by consumers on many types of loans, such as adjustable rate mortgages, home equity lines and credit cards, as well as for many types of business loans.

Typically, the Fed lowers rates when it is concerned about the economy slowing and raises rates when it is more worried about inflation.

With that in mind, some economists believe the Fed will begin raising rates as soon as this summer in order to combat rising commodities prices. Others believe that rate hikes are more likely in early 2009.

Rates are too low...

But few are expecting the Fed to cut rates again soon. In fact, some think that low interest rates are at least partly responsible for some of the serious drags on the U.S. economy today, such as soaring prices of food and gas and the weak dollar.

Rich Yamarone, director of economic research at Argus Research, said it is fair to blame the Fed "for a portion of the dollar's weakness and higher commodity prices."

The problem, according to some economists, is that the Fed didn't cut rates enough last year in response to the subprime mortgage meltdown and subsequently was forced to cut rates by a large amount this year.

The Fed lowered its fed funds rate by a half-point in September and followed that up with just quarter-point cuts in October and December.

"If policymakers had been more aggressive back in the fourth quarter, the financial system and the economy would not have gotten to this point, and the Fed would not have had to respond in such an aggressive way," said Mark Zandi, chief economist of Moody's Economy.com.

The Fed slashed rates by three-quarters of a percentage point in an emergency meeting on January 21 and lowered them by another half-point at its regularly scheduled meeting nine days later.

That was followed by another three-quarters of a percentage point reduction in March and a quarter-point cut in April.

Lakshman Achuthan, managing director of the Economic Cycle Research Institute, said these big cuts opened the door to the inflationary pressures we've seen in the past few months. He also thinks that the Fed wouldn't have needed to go as far as it did if it had not "dragged its feet" on rate cuts last year.

"You can not make up for being late by doing extra. The tonic of lower rates turned toxic," Achuthan said.

...or right where they should be?

But there are other economists who believe that the economy is still fragile enough to justify the Fed cutting rates this deeply.

"I think the worst of the recession is yet to come. So I think the Fed is right to bring rates down this far," said David Wyss, chief economist with Standard & Poor's.

Other defenders of Fed policy believe the economic slowdown will eventually end up reducing demand for oil and other commodities. That would lead to price declines.

In addition, some economists think that factors out of the Fed's control are the real reasons for the rise in oil and food prices.

"If the Fed had cut rates to 2.5% instead of 2%, it wouldn't have made any difference for oil," said Ethan Harris, chief economist with Lehman Brothers.

He added that the boom in global demand for oil combined with the fact that many investors are chasing momentum in the commodities markets are the real culprits behind oil's surge, not the Fed.  To top of page

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