The quarter-point cut reinforces confidence in a number of ways, Hummer says: It meets investors' expectations, sets aside the notion that the Fed is still preoccupied with the threat of inflation, and tells big financial institutions that the central bank recognizes the problems they're having with the fallout from the subprime mortgage debacle.

In Hummer's estimation, a quarter-point cut gives the Fed more options. When the rate-setting panel meets next month, it's free to do nothing, cut a quarter-point or cut a half-point, without lending the impression that it's veering off course.

Rate-cut effects
Fed rate cuts don't always have the expected effects. Yields on certificates of deposit usually follow the Fed. But when the Fed cut half a percentage point on Sept. 18, high-yield CDs didn't fall nearly as much. On Sept. 18, the average yield on a one-year, high-yield CD was 5.2 percent, according to Bankrate's weekly survey; the average yield had fallen 12 basis points, to 5.08 percent, five weeks later. Over the same time, three-month high-yield CDs dropped 20 basis points, from 4.93 percent to 4.73 percent.

Mortgages don't always react as expected, either. The 30-year fixed averaged 6.32 percent nationally the day after the Sept. 18 Fed rate cut. It rose and then fell -- ending up at 6.31 percent last week.

Banks charge the federal funds rate to one another for overnight loans. The Fed controls the federal funds rate indirectly, by selling and buying securities to add and subtract cash from the banking system. Eight times a year -- roughly every six weeks -- the FOMC meets. The prime rate is 3 percentage points higher than the federal funds rate.

Historical perspective
At the beginning of 2001, the Federal Reserve cut short-term interest rates swiftly -- 3 percentage points in four months -- to cushion a recession. More gradual rate-cutting followed. Starting in June 2004, the Fed raised rates, a quarter-point at a time, for two years. Now the Fed has cut the federal funds rate twice in a row, and there's no telling how many are to come.

Federal funds rate 2001-2007