Fed Ready to Slash Interest Rates Amid Deepening Recession
December 16, 2008 - 5:12 AMWith the Fed's key rate dropping ever closer to zero, the central bank is moving into uncharted territory.
With the Fed's key rate dropping ever closer to zero, the central bank is moving into uncharted territory.
Nonetheless, Fed Chairman Ben Bernanke has made it clear the Fed isn't running out of ammunition to fight the worst financial crisis since the 1930s. It is exploring using tools -- other than rate cuts -- to revive the economy. New insights on that front could be revealed when Bernanke and his colleagues wrap up a two-day meeting Tuesday.
"The message is simply the Fed stands ready to do everything in its power to stop the economy's free fall," said Richard Yamarone, economist at Argus Research.
In its battle against a recession that started last December, the Fed already has cut the target for the federal funds rate, its main tool for influencing economic activity, to 1 percent, a level seen only once before in the last half-century.
Many economists predict the Fed will cut the funds rate in half -- to just 0.50 percent. A few think the Fed could opt for an even more forceful action -- lowering rates by a whopping three-quarters percentage point or more. If that larger cut occurs, it would be the lowest on records that track the monthly average of the funds rate going back to 1954. The funds rate is the interest banks charge each other on overnight loans.
The benefit of another Fed rate reduction, though, may be mostly psychological, rather than economic.
"It's a feel-good thing," said economist Ken Mayland, president of ClearView Economics. "Hopefully this is a bridge to better confidence."
Slammed by the financial crisis, worried banks have hoarded their cash and been extremely reluctant to lend money to customers. Fearful consumers, watching jobs vanish and their investments tank, have sharply cut back their spending, including on big-ticket purchases like homes and cars that typically involve financing.
In response to the Fed's expected action, the prime rate -- now at 4 percent -- for many consumer and small-business loans would drop by a corresponding amount. The prime lending rate is used to peg rates on home equity loans, certain credit cards and other consumer loans. Cheaper rates could give pinched borrowers a dose of relief.
The goal of lower borrowing costs is to entice people and businesses to spend more, which would revive the economy. So far, though, the Fed's aggressive rate reductions have failed to stabilize the economy.
Bernanke says the Fed is weighing other ways to aid the economy given that it can lower the funds rate only so far -- to zero.
For example, the Fed could buy longer-term Treasury or agency securities on the open market in substantial quantities. This might lower rates on these securities and help spur buying appetites.
A Fed program announced late last month to buy $600 billion in debt and mortgage-backed securities from mortgage giants Fannie Mae and Freddie Mac already has helped pushed mortgage rates down.
By boosting the quantity of money in the financial system, the Fed has engaged in so-called "quantitative easing" to provide economic relief. The Fed's balance sheet has ballooned to $2.2 trillion, from close to $900 billion in September, reflecting efforts to mend the financial system.
"Never in the postwar history has the Fed acted as lender of last resort to this degree," Mayland said.
In fact, with all the lending by the Fed, the actual funds rate has fallen at times well below its current 1 percent target.
As housing, credit and financial problems persist, the economic rubble mounts higher.
Shell-shocked employers axed 533,000 jobs in November alone. That drove the unemployment rate up to 6.7 percent, a 15-year high.
Since the start of the recession, the economy has shed nearly 2 million jobs. Analysts predict another 3 million more will be lost between now and the spring of 2010.
Last week alone, Bank of America Corp., tool maker Stanley Works and Sara Lee Corp., known for food brands such as Jimmy Dean and Hillshire Farm, announced job cuts.
General Motors Corp. and Chrysler LLC, are in danger of running out of money within weeks and are seeking government aid. The White House is exploring ways to throw a lifeline to Detroit after rescue efforts collapsed in Congress.
With the employment market eroding and consumers retrenching, the economy could stagger backward at a shocking 6 percent rate in the current October-December quarter, analysts predict. It shrank at a 0.5 percent pace in the third quarter.
President-elect Barack Obama is advocating an economic recovery plan that includes spending on big public works projects to bolster jobs. His plan also includes tax cuts to spur consumers to spend more and businesses to step up investment and hiring.
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