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‘Fed must act to avoid recession’

Concerns have been raised that the US economy could fall into recession unless the Federal Reserve acts decisively on interest rates.

Komal Sri-Kumar, chief global strategist at US investment firm Trust Company of the West, says the Fed must not use moral hazard as an excuse to maintain interest rates.

He says: “Moral hazard refers to the incentive for banks to make risky loans or for individuals or institutions to make reckless investments. Returns could be attractive on the upside but the entities would not have to bear the full cost if things turn sour, creating the hazard.

“Former Fed chairman Alan Greenspan is supposed to have contributed to such situations in 1987, 1995, 1998 and 2001 when monetary policy was eased in response to crises.”

Sri-Kumar disagrees with the argument that a cut in the Federal funds rate would ease the plight of investors, hedge funds and buyout firms which bet the wrong way, encouraging similar investment patterns in the future. He says: “We find the argument to be specious. We doubt a reduction in the Federal funds rate today would result in a surge of imprudent investments and loans.”

He says the longer the Fed waits, the more substantial will be the reduction in the Federal funds rate needed to avoid recession or restore financial stability.

Sri-Kumar says: “If the Fed does not act before the next scheduled meeting of the Federal open markets committee on September 18, it could require a full percentage point cut.”

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