Fed Cuts Discount Rate to 5%--an 18-Year Low : Economy: The action is an attempt to jump-start the sluggish recovery. Major banks quickly reduce prime.
In an attempt to jump-start the nation’s sluggish recovery, the Federal Reserve Board moved aggressively Friday, slashing the discount rate, the benchmark interest rate that it charges on loans to commercial banks, by half a percentage point, to 5%--its lowest level in 18 years.
The Fed also cut a second widely watched interest rate, which commercial banks charge one another for overnight loans, by a quarter of a point, to 5.25%.
At the White House, President Bush hailed the Fed’s actions as “good news,” telling reporters that “the lower interest rates (are), the more economic growth.”
The Fed’s actions prompted leading commercial banks to reduce their prime lending rates by half of a percentage point, to 8%, a five-year low. The drop will lead to lower borrowing costs on an array of business and consumer loans that are tied to the prime. Mortgage rates, already at their lowest levels since the 1970s, are likely to decline as well.
The interest rate reductions followed government reports that retail sales fell 0.7% last month after a strong showing during the first half of the year, and that consumer prices rose for the third month in a row, by a modest 0.2%.
The stock market initially rose on the news of the rate cuts, but then sellers flooded the market.
“It’s the old saying of ‘buy on the rumor, sell on the news,’ ” said one analyst, explaining that the market had been anticipating the interest rate reductions.
The Dow Jones industrial average closed down 22.14 points at 2,985.69.
The fact that commercial banks began to act immediately to lower rates heartened analysts, because it indicated that the Fed’s latest moves, which had been widely predicted, may have a more immediate effect on the economy than did its rate cuts earlier in the year.
During the depths of the recession last winter, several Fed rate cuts were ignored by the nation’s ailing commercial banks, which kept their interest rates high in order to improve their profitability.
Yet some critics of the Fed in Congress argued that the Fed’s actions will not relieve the credit pinch that has made it increasingly difficult for American businesses and consumers to borrow money. Senate Banking Committee Chairman Donald W. Riegle Jr. (D-Mich.) noted that in 1973, when the Fed’s discount rate on loans to commercial banks was last at 5%, the prime rate stood at just 6%--2 percentage points lower than today.
The current weakness in the nation’s commercial banking system has reduced the Fed’s ability to manage interest rate policy, Riegle and others charged. “The Fed has lost control,” said House Banking Committee Chairman Henry B. Gonzalez (D-Tex.).
The unanimous decision by the Fed’s Board of Governors to lower rates reflects a growing concern within the central bank over the lingering weakness of the economy, Fed officials and outside analysts said. Several leading Fed officials said they moved as a result of recent figures showing surprisingly weak growth in the nation’s money supply--data suggesting that the recovery remains tenuous and could stall over the coming months.
“This was all about the slowness in money growth,” said Lee Hoskins, president of the Federal Reserve Bank of Cleveland.
“We never expected a really strong recovery, but what has surprised us is the slowness in money growth,” added another senior Fed official.
The economy’s stagnation was underscored by the drop in retail sales. The 0.7% decline is the steepest since a 1.3% plunge last January, when the economy was still deep in recession.
In addition, the nation’s auto makers on Friday reported a sharp 15.4% drop in car and truck sales during early September, indicating that America’s industrial heartland is not yet enjoying as dramatic an upturn as some economists had hoped. As a result, many economists now expect unemployment to remain stubbornly high for the rest of the year, perhaps close to 7%.
The fall in retail and auto sales increased concern among leading economists that the nation might slip back into recession. Several, in fact, renewed earlier charges that the Fed is still moving too timidly to buoy the economy.
“After the numbers we got (on retail sales), I would have been shocked if they hadn’t cut rates,” said Lawrence Chimerine, an economist with the Economic Strategy Institute in Washington.
“The Fed is just catching up, after moving too slowly before,” added David Wyss, an economist with DRI-McGraw Hill, an economic forecasting firm based in Lexington, Mass.
The Labor Department report that the consumer price index rose just 0.2% in August signals that inflationary pressures are on the wane and gives the Fed the flexibility to cut interest rates without risking a rise in prices.
In fact, Fed Chairman Alan Greenspan and other senior Fed officials now believe that inflation’s back has been broken by the central bank’s relatively tough monetary policies of the last few years. As a result, Fed officials expect the inflation rate to remain low for the foreseeable future.
Many private economists said they are much more concerned about the pace of recovery than about the threat of inflation; most expect consumer prices to rise by an annual rate of only about 3% over the next year or two.
With inflation moving down toward lows not enjoyed in the United States since the early 1970s, most economists believe that the Fed will be able to keep interest rates low for at least the next year.
