federal reserve

Fed cuts key interest rate

The Federal Reserve cut its target for the federal funds rate to a range between 0 percent and 0.25 percent and promised to keep it there "for some time."

Fed chops rate

0-0.25%

The Fed slashed at least three-quarters of a point off a key interest rate.

By reducing the target rate from 1 percent to as low as 0 percent, the central bank acknowledged reality. The prime rate will fall to 3.25 percent. The federal funds rate had been hanging around in the Fed's target range since Dec. 4, anyway.

The central bank said it will "employ all available tools" to stimulate the economy and prevent deflation. The Fed sent an unmistakable signal that it wants lenders to lend and consumers and businesses to borrow. It wants to discourage saving. Rates and yields on savings accounts, such as certificates of deposit, were already low and probably will fall even further.

The rate-setting Open Market Committee issued an unusually long policy statement. Instead of the usual four paragraphs, this one was seven paragraphs long. The key paragraph -- a distillation of Chairman Ben Bernanke's philosophy of how to respond to a financial crisis -- was the fourth. It read:

"The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time."

Bernanke was a Princeton economist before joining the Federal Reserve Board, and he focused his academic career on economic depressions and how to avoid them. Many of his conclusions can be boiled down into the paragraph above, which can be rephrased as:

  • Throw everything, including the kitchen sink, at the problem.
  • Promise to keep short-term rates low until there is evidence that economic growth has resumed -- lasting economic growth, not just a blip.
Don't worry: We'll just print more
Bernanke's solution includes a combination of long-lasting rate cuts and something he previously has called "quantitative easing," which essentially means printing lots of money. In its policy statement, the Fed phrased it as "sustain(ing) the size of the Federal Reserve's balance sheet at a high level."

Last month, the Fed announced that it would crank up the printing press to create billions of dollars and use the new money to buy mortgage-backed securities. The Fed's goal is to drive mortgage rates lower while introducing so much money into the system that banks will lend it to consumers, businesses and other banks. The central bank reiterated that intention in this rate policy statement.

These actions are straight out of the road map that Bernanke drew in speeches in 2002 and 2004. In the 2002 speech, Bernanke, then a Fed governor, described what he called the "zero bound" problem caused by a federal funds rate at or near zero percent. "Of course, the U.S. government is not going to print money and distribute it willy-nilly," Bernanke said. He described where the Fed could put the money:

  • It could buy U.S. Treasury bonds and notes.
  • It could lend money to banks at low interest, and accept corporate bonds, commercial paper and mortgages as collateral.
  • It could buy mortgage-backed securities.
  • With permission from Congress, it could buy corporate bonds.

The Fed already is lending money to banks and accepting all sorts of stuff as collateral, and plans to buy mortgage-backed securities soon. The central bank says it "is also evaluating the potential benefits of purchasing longer-term Treasury securities." And under the Troubled Assets Relief Program, or TARP, the Fed and Treasury could buy corporate bonds.

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