Fed Reduces Key Rate a Half Point : Finance: The charge for overnight loans to commercial banks is trimmed to an 18-year low of 4.5%. The action is designed to stimulate the economy.
Acting for the second time in as many weeks to pump more money and confidence into a faltering economy, the Federal Reserve moved decisively Wednesday to reduce interest rates by lowering its benchmark discount rate to an 18-year low of 4.5%.
The half-point reduction in the rate the Fed charges on overnight loans to commercial banks was clearly designed to force down interest rates paid by businesses and consumers in an effort to stimulate more borrowing and to breathe new life into the apparently faltering recovery.
In announcing the rate cut before the start of trading on the nation’s financial markets, the Fed cited “sluggish expansion” of the money supply and available credit and left no doubt that it was responding to signs that the economy is in danger of lapsing back into recession.
Although the Fed’s move triggered quick action by a number of major banks, which announced that they were cutting their prime lending rates a half point to 7.5%, some analysts questioned whether the tonic of lower rates will be strong enough to revive the ailing economy.
Interest rate cuts traditionally have been a key strategy for combatting recession. By reducing the cost of borrowing, they tend to stimulate consumer purchases of houses, cars and other big-ticket items and to encourage more investment by businesses.
But some analysts fear that the weak recovery may be less responsive to rate reductions because debt levels are unusually high, consumer confidence is slumping and many banks are skittish about making new loans, and they worry that the economy might slide back into recession.
“The credit crunch remains with us. Even if the Fed makes money cheaper, the banks don’t want to lend,” said economist David Wyss of DRI/McGraw Hill, a Lexington, Mass., forecasting firm.
“Lower interest rates have been slow to have any impact,” added Allen Sinai, chief economist with the Boston Co. in New York. “The credit supply channel has not been working normally, and the demand isn’t there. Households and businesses are unwilling to borrow and spend.”
The increasingly gloomy outlook has become a major worry for President Bush, whose popularity has flagged along with the economy. Opinion polls show that many Americans believe the President has neglected domestic problems as he has concentrated on foreign affairs.
Constrained by a massive federal deficit and last year’s budget accord from stoking the economy through new spending or tax cuts, the Administration instead has pressured the Fed to stimulate the economy with repeated interest rate cuts.
Wednesday’s reduction was hailed by Treasury Secretary Nicholas F. Brady as “good news for the economy.” Brady said that the cut “will provide stimulus for economic growth, spur incentive for business investment and increase consumer confidence.”
It was the fifth discount rate cut in less than a year. The Fed began dropping the rate last December, nudging it down a half point from 7% as the recession clearly began to worsen. It has made four half-point reductions since then.
The action was approved by the Fed’s board of governors on a 4-1 vote, with Wayne D. Angell dissenting. There are two vacancies on the seven-member board. The Fed noted that the directors of seven of the Federal Reserve system’s member banks had recommended the move.
Last week, the Fed let a parallel short-term interest rate, the federal funds rate, drop a quarter of a point to 5%, and it appeared Wednesday that the central bank was again injecting money into the banking system to lower the fed funds rate to 4.75%, which would be its lowest level since 1977.
The federal funds rate is the interest that banks charge one another for overnight loans. Unlike the discount rate, which the Fed governors set by decree, the federal funds rate is manipulated indirectly by the central bank’s monetary policy-making arm, the Federal Open Market Committee.
Fed Chairman Alan Greenspan for several months has expressed fears that slow growth in the nation’s money supply and reluctant lending by banks already burdened with bad loans were producing a growth-killing credit crunch.
The nation’s economy, which struggled to a sluggish 2.4% annual rate of growth in the third quarter after two successive quarters of shrinkage, is struggling forward against “50-mile-an-hour head winds,” Greenspan observed last week.
But it was not immediately clear whether the Fed’s rate cuts would keep the recovery moving. Economist Wyss said that in the current economic climate, the Fed’s monetary policy has become “a centipede,” inching along step by step by step. At least one more rate cut may be necessary before the end of the year to stave off a “double-dip” recession, he said.
Wyss noted that with billions of dollars flowing daily from one international market to another, actions by the central bank in Washington now have less impact than in previous business cycles and the lag time between interest rate cuts and economic stimulus is longer.
Although the Fed’s discount rate has dropped to 4.5%, the lowest level since early 1973, long-term interest rates have not fallen in tandem. Prevailing rates on long-term bonds have remained at about 8%, Wyss said, apparently so they will remain competitive with rates available in other nations.
“The bottom line of the Fed action here is that there really isn’t a recovery yet,” added Sinai, the Boston Co. economist. “The revelation that nothing much has happened to make the economy grow is just hitting the Fed, and has just hit the Administration.”
Michael J. Boskin, chairman of the White House Council of Economic Advisers, said in a televised interview that the Administration believes the economy will be in much better shape by next spring as the effect of the repeated rate reductions takes hold. But, he said, the next few months appear problematic.
“One has to form a judgment about what all this negative news that has been hyped by the media will do to consumer psychology, consumer purchases and business investment,” Boskin said.
Wednesday’s rate cut had been widely anticipated on the nation’s financial markets, and the official announcement produced a muted response. The Dow Jones industrial average gained 7.15 points to close at 3,038.46.
Meanwhile, a group of conservatives who have criticized the Administration’s handling of the economy urged Bush to replace Treasury Secretary Brady with Housing Secretary Jack Kemp.
“President Bush needs to send a strong, pro-growth message to the American public,” said John Cregan, president of the Business and Industrial Council. “The economy is struggling. The President must exert leadership.”
Cregan’s group said that it had been dismayed to learn that Brady had urged the President to avoid pushing for a tax cut. Kemp, the conservatives said, would be more likely to promote an economic growth package containing a cut in the capital gains tax.
Federal Reserve Discount Rate Drops
Interest the Federal Reserve charges commercial banks for loans.
Prime Rate Also Falls
With the discount rate lowered to 4.5%, major banks lowered their prime lending rate to 7.5%. That’s the rate bankers use to calculate a range of consumer and business loans such as student loans, home equity loans and some type of car loans. 1986: 7.5% 1991: 4.5%
