Fed Trims Key Lending Rates by Half a Point

WASHINGTON — The Federal Reserve cut key interest rates another half a point Wednesday in an effort to keep an already stumbling U.S. economy from lurching into recession.

Fed policymakers accompanied the cuts with a statement that all but guaranteed more rate reductions aimed at breaking a nasty cycle of declining confidence, shriveling consumption, tumbling investment, falling production and growing layoffs.

The central bank acted only hours after government statisticians announced that the economy grew at its slowest pace in 5 1/2 years during the final three months of 2000, and that one of the stalwarts of the nation’s long boom--business investment--actually fell for the first time since the early 1990s.

Gross domestic product, a measure of the country’s total output of goods and services, grew at a mere 1.4% annual rate during the fourth quarter, a far cry from the 4%-plus growth rates it had posted until recently. Though the economy continues to give mixed signals, many economists, including Fed Chairman Alan Greenspan, say that growth may have stalled altogether.

The Fed’s policymaking Open Market Committee cut its target for the federal funds rate--the interest banks charge each other for short-term loans--half a point from 6% to 5.5%. Coming atop a similar cut Jan. 3, the action completed the most aggressive interest rate reduction in Greenspan’s 14-year tenure.

The nation’s financial institutions set their interest rates in substantial measure based on the funds rate. So a reduction in that rate eventually turns up as lower interest on everything from business loans to credit card bills.

The Fed coupled Wednesday’s funds rate cut with an identical reduction in the largely symbolic discount rate, the interest the Fed itself charges banks for loans.

Investor reaction to the rate cuts was muted.

Stock buyers, apparently disappointed the cuts were not larger, knocked 65.62 points, or 2.3%, off the technology-laden Nasdaq composite index. They trimmed 7.72 points, or 0.6%, off the S&P; 500 index, which closed at 1366.01. Among the major indexes, only the Dow Jones industrial average was up, but only 6.16 points to 10,887.36.

Bond investors reacted by driving up the price of the U.S. Treasuries, sending their yields, or market interest rates, down. The yield on a 10-year Treasury note fell to 5.12% from Tuesday’s close of 5.22%.

In its action Wednesday, the Fed portrayed the economy’s condition as even bleaker than when the central bank first cut rates Jan 3.

“Consumer and business confidence has eroded further, exacerbated by rising energy costs that continue to drain consumer purchasing power and press on business profit margins,” the Fed said. “Retail sales and business spending on capital equipment have weakened appreciably. In response, manufacturing production has been cut back sharply.”

Policymakers said the combination “called for a rapid and forceful response of monetary policy,” a phrase veteran Fed watchers said was one of the most urgent to emerge from the normally reserved institution in recent memory.

“They are desperately trying to keep the economy from slipping into a prolonged recession,” said Sung Won Sohn, executive vice president and chief economist of Wells Fargo Banks in Minneapolis.

“The dynamic they’re describing is a pretty nasty one,” said Robert V. DiClemente, chief U.S. economist with financial giant Citigroup in New York.

Economists predicted that the Fed would cut another half a point from the funds rate by its next policy meeting March 20, and could follow up with a series of smaller cuts. If all goes as hoped, the economy would return to robust growth by late this year.

The central bank may get some help from President Bush and lawmakers, who will begin debate shortly on a $1.6-trillion tax-cut proposal that the administration says could provide the economy with an extra boost. Officials met Wednesday to discuss ways to get the cuts’ benefits to consumers more quickly.

Fed policymakers also will be helped by an economy that, for all its troubles, still has some steam. The latest evidence: a report Wednesday showing that new-home sales unexpectedly jumped in December to their second-fastest pace.

Sales increased 13.4% in December to a seasonally adjusted annualized rate of 975,000 houses, according to the Commerce Department. That was a sharp reversal from November’s 7.1% decline and the highest sales rate since the 995,000 record set in November 1998.

Even with the show of strength in housing, however, the economy is substantially weaker than the central bank believed even two months ago. Some critics charge that is partially the result of half a dozen Fed-engineered interest rate hikes during 1999 and the first half of 2000.

Indeed, the central bank insisted until mid-December that inflation, not recession, was the biggest threat facing the economy. Even when it changed its mind at the Dec. 19 meeting, it refused to cut rates.

Since then, the central bank has been hit with a string of bad news. Industrial production fell 1.1% in December, its biggest decline in almost a decade, and consumer confidence took its largest dive since the recession of the early 1990s.

“We’re no longer in the economic nirvana we enjoyed the last five years,” said Paul L. Kasriel, economic research director for Northern Trust Co. in Chicago. “We’re going to see more trouble” before things improve.

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Cause and Effect

Over the last 40 years, the Federal Reserve has frequently jump-started the economy by cutting interest rates and nudged it into recession by increasing rates.

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Sources: Commerce Department, Federal Reserve

Gross Domestic Product

Percentage change from previous quarter, annualized real rate:

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2000 fourth quarter: 1.4%

Source: Commerce Department