Fed Cuts Short-Term Rates
The Federal Reserve moved Tuesday to insulate the U.S. economy from a recession sweeping around the globe as the central bank cut the key federal funds rate by a quarter-percentage point to 5.25 percent.
The Fed left the discount rate unchanged.
"The action was taken to cushion the effects on prospective economic growth in the United States of increasing weakness in foreign economies and of less accommodative financial conditions domestically," the Fed's policy-making committee said in a statement."The recent changes in the global economy and adjustments in U.S. financial markets mean that a slightly lower federal funds rate should now be consistent with keeping inflation low and sustaining economic growth going forward," the Federal Open Market Committee said.
The fed funds rate is the rate at which banks borrow from each other to meet reserve requirements. The discount rate is the rate at which banks borrow from the Fed itself to meet reserves. Many banks peg their prime interest rate to the fed funds rate. But many other rates bear no close relationship to the fed funds or discount rates. For example, the yields on all government securities are lower than the overnight fed funds rate.
The first rate cut January 1996 came as no surprise to financial markets. About the only thing the Fed's announcement settled was the question of how much it would ease rates.
Economists agreed a cut was necessary to restore confidence and to ease an expected credit crunch.
On the news, financial markets instantly recoiled as the blue-chip Dow Jones Industrial Average dropped 80 points on disappointment that the Fed had not lowered the fed funds rate a half-point. Bond prices rebounded.
Major banks were expected to lower the interest rate they charge their best customers almost immediately.
"The rate cut will be followed by others," said Irwin Kellner, chief economist for CBS.MarketWatch.com and the Weller professor of economics at Hofstra University in Hempstead, N.Y.
Three months ago, the Fed was leaning toward raising ratesbut that was before Russia defaulted on its debt obligations and nervous investors began pulling their capital out of any investment riskier than a Treasury bond.
Federal chief Alan Greenspan set the stage for a rate cut with a speech in California on Sept. 4, when he warned that the United States couldn't remain "an oasis of prosperity." He seemed even more committed last week when he told senators that quick action was needed to restore global confidence.
And then the collapse of the Long-Term Capital Management hedge fund drove home the point that even powerful U.S. financial institutions feel the effects of the downturn hitting nations from Japan to Russia to Brazil.
Short-term interest rates have remained remarkably stable for nearly three years as the U.S. economy enjoyed sustained growth and low inflation. The Fed bumped up the fed funds rate by a quarter-point in March 1997, but otherwise has left interest rates unchanged since the last reduction in January 1996.
Written By Rex Nutting, Washington bureau chief for CBS MarketWatch