Fed Cuts Key Loan Rate to Stimulate Economy : Charge for Lending to Banks Falls to 7.5%, Lowest in Nearly 7 Years; More Institutions Reduce Prime
The Federal Reserve, worried about the lingering weakness of the U.S. economy, Friday lowered the lending rate it charges banks and other financial institutions by half a percentage point to 7.5%.
The Fed’s discount rate, which has not been so low in nearly seven years, hit a record high of 14% in the spring of 1981. The latest move is the third time that the Fed has lowered the rate since last November.
The discount rate is one of the blunter instruments used by the Fed to help influence broad economic conditions, and any move in the rate is widely regarded as a clear signal of the central bank’s often-murky intentions about the proper direction for interest rates. By lowering the rate, the Fed is hoping to encourage more borrowing, thereby stimulating the lagging economy.
‘This Is the Signal’
“This is the right move at the right time,” said Irwin Kellner, chief economist at Manufacturers Hanover Bank in New York. “It shows the Fed’s priorities are clearly in favor of promoting growth in the economy. This is the signal the banks have been waiting for.”
Indeed, only minutes after the Fed’s announcement, New York’s Citibank and Chase Manhattan Bank, the nation’s second and third largest commercial banks, cut their prime lending rates to 10% from 10.5%. Another major bank, Bankers Trust Co. of New York, had lowered its rate to 10% on Wednesday, and analysts predicted that other big banks would quickly fall in line now that Citibank and Chase have moved.
The Fed, in a typically cryptic statement explaining its move, said that it was acting in part because of “relatively unchanged output for some time in the industrial sector of the economy, stemming heavily from rising imports and the strong dollar.”
The most recent figures for the nation’s gross national product, adjusted for inflation, pointed to an annual growth rate of just 1.3% in the first quarter of this year. And several analysts said that they expect revised estimates, to be released by the Commerce Department next Tuesday, to show that the economy grew even more slowly than that.
Industrial production has grown barely at all since last summer and, even though many leading economists expect economic growth to pick up later this year, others have become so discouraged by the latest business reports that they have begun to warn of the dangers of a recession.
“I’m a little surprised the Fed moved so quickly, but it is clearly good news,” said Jerry J. Jasinowski, chief economist for the National Assn. of Manufacturers. “It indicates they are concerned that growth in the second quarter is going to be very slow. This should set the stage for a rebound, but interest rates may have to come down a bit more before we will see a real turnaround.”
Further Decline Possible
In an interview Wednesday, Preston Martin, vice chairman of the Fed’s board, said that he was disappointed in the economy’s performance and hinted that the Fed was prepared to see interest rates fall further in an attempt to prevent a so-called “growth recession”--economic growth so anemic that unemployment rises.
Most interest rates have fallen in recent weeks, in part because of the expectation that the Fed would be forced to ease credit conditions to prevent further economic slippage.
The Fed anticipated criticism that its latest reduction in interest rates, by encouraging more borrowing, might allow the nation’s money supply to grow too fast. It noted that inflation remains “relatively well contained in the goods-producing sectors of the economy, and sensitive commodity prices are generally at the lowest levels in about two years.”
The Fed’s statement added that “growth of the monetary aggregates has slowed appreciably, although M-1 (the most closely watched money supply figure) has remained somewhat above the path implied by the annual target.”
M-1 Up, M-2 Down
The Fed announced Thursday that M-1, a measure of money in cash and checking accounts, had jumped more than expected in the previous week. But M-2, which adds most saving accounts and money market funds to M-1, dropped last month for the first time in five years.
The Fed’s policy-making arm, the Federal Open Market Committee, will meet for two days next week, and several analysts predicted that it would make further decisions then to encourage faster economic growth.
But economists were wary of forecasting additional interest rate declines.
“The discount rate has a lot of symbolic importance in ratifying drops in interest rates,” said Michael Bazdarich, a monetary analyst at Claremont Economics Institute in Claremont, Calif. “But we won’t be able to tell for a while whether the Fed is going to actively push rates down further.”
‘Just the Medicine’
And Kellner predicted that the bank prime rate would stabilize at 10% for a while until it is clear whether the economy is moving up or down. “This is just the medicine the economy needed,” said Richard Rahn, chief economist at the U.S. Chamber of Commerce and a frequent critic of the Fed. “The key thing is to keep the recovery going.”
The Fed, following practice, announced the discount rate move on a Friday after the New York Stock Exchange closed, giving investors the weekend to consider its significance.
The decision by the Fed’s governors was taken on a 5-0 vote. Board members Emmett Rice and Martha Seger were absent.
