Fed Lowers Loan Rate; Prime Drops : U.S. Acts in Concert With W. Germany and Japan to Spur Economic Growth
The Federal Reserve cut a key interest rate to 7% from 7.5% Friday in a coordinated action with West Germany and Japan aimed at stimulating further economic growth in the United States and other leading industrial nations.
The drop in the Fed’s discount rate--a largely symbolic rate that the central bank charges financial institutions for emergency borrowing--immediately spurred cuts in the prime lending rates of nearly all banks to 9% from the 9.5% level at which they had been stuck since last June.
Other short-term interest rates also fell, but long-term rates in the bond market--where the Fed’s move had already been widely anticipated--were little changed. The stock market edged up, with the Dow Jones Industrial Average gaining 3.23 points to close the week at 1,699.83.
Help for Third World
The White House welcomed the discount rate cut. President Reagan’s chief economic adviser, Beryl W. Sprinkel, pointed out that the discount rate drop is in line with the general decline in interest rates over the last few months. He said lower interest rates would benefit the U.S. economy this year and should help relieve some of the pressure on heavily indebted Third World nations such as Mexico and Brazil.
Several economists suggested that interest rates would probably remain relatively stable over the next few months until it becomes clear whether the economy has picked up speed again after more than a year of weak growth. If the economy does continue to improve, they said, rates might start rising later this year.
Analysts said that the Fed waited until Germany’s Bundesbank agreed to drop its own discount rate because Fed Chairman Paul A. Volcker was afraid that unilateral action by the United States might set off a free fall in the value of the dollar.
“There’s a strong case for lower (interest) rates in all three countries, but none of them wanted to do it alone,” said Robert Solomon, an international economist at the Brookings Institution. “As it stands, they are all doing something desirable for each country without having any significant effect on exchange rate levels.”
The U.S. currency has already dropped about 30% in value in the last year and has fallen rapidly since last September, when top economic officials of the United States, West Germany, France, Japan and Britain announced in New York a joint effort to bring down the overvalued dollar.
The dollar’s decline is expected to help reduce the huge U.S. trade deficit by effectively lowering the price of American goods in world markets and raising the cost of foreign products.
The Reagan Administration has been pushing hard for lower rates here and abroad, particularly favoring more stimulative policies in other countries to help increase the demand for U.S. goods.
Treasury Secretary James A. Baker III, who initially failed at a January meeting in London to promote an international agreement to lower interest rates, hailed the joint steps. “I strongly support moves by Germany, Japan and the United States to lower their discount rates,” Baker said.
Nations Act Within Hours
The Fed’s move followed within hours similar actions by monetary officials in Europe and Japan. West Germany reduced its discount rate Thursday to 3.5%, joined quickly by similar half-percentage-point rate cuts in the Netherlands, France and Canada. Japan’s central bank officially disclosed a cut to 4% in its lending rate just before the Fed’s unusual early morning announcement of the discount rate cut.
The Fed normally announces any changes in the discount rate in the late afternoon, after most financial markets have closed for the day. Its discount rate was last cut, to 7.5% from 8%, in May, 1984. The discount rate, which reached a high of 14% in 1980, has not been as low as 7% for nearly eight years.
Last month, Volcker expressed fears that the dollar was falling too fast, suggesting that he would oppose any further interest rate declines if they threatened to cause a plunge in the value of the dollar. At a meeting Thursday night, however, Volcker joined with five other board members in unanimously approving the cut. Board member Martha Seger was absent.
Economists suggested also that the sharp increase in the unemployment rate in February, a disclosure that was available to top government officials on Thursday, gave the Fed a good reason to add a bit of stimulus to the economy with an immediate drop in the discount rate.
‘Shot in the Arm’
“It looks like this had been in the works for some time,” said Robert Gough, senior vice president at Data Resources Inc., an economic forecasting firm in Lexington, Mass. “Right now, it is a real shot in the arm.”
Analysts said that the greatest pressure for the coordinated rate cuts came from Japan, which particularly needed the stimulus of lower interest rates to compensate for the battering its export industries are taking from the extremely rapid increase in the value of the Japanese yen.
Japan had cut its discount rate last month but was unwilling to reduce it again on its own because it did not want to be accused of deliberately weakening the yen simply to protect its own export industries.
Once West Germany agreed to cut its interest rates, the door was open for both Japan and the United States to lower rates without risking large currency swings.
In Japan, even before the Fed’s discount rate move was announced, central bankers privately described their own rate cut as a joint action taken to “create an environment” that would allow the United States to push interest rates down.
Little Fear of Inflation
The Fed, in announcing its discount rate cut, stated that it had little reason to fear inflation at the moment, pointing out that “continuing restraints on costs have been further enhanced by the recent sharp declines in oil prices, and the economic expansion appears to be proceeding within the nation’s growth potential.”
The moves by the central banks capped a week in which long-term interest rates declined substantially while short-term rates remained relatively stable. Rumors swirled all week through the bond market that President Reagan’s four appointees to the Fed board were determined to push through a discount rate cut even if Volcker were opposed, but Fed officials denied any such action.
Staff writer Sam Jameson in Tokyo contributed to this story.
