A committee of the Federal Reserve is expected to cut a key interest rate on Tuesday to trickle more money into the economy and encourage Americans to spend.
Will the Fed committee’s expected action do any good? Economists believe that it will, even if the expected rate cut is partly a symbolic gesture.
The consensus among economists is that the Federal Open Market Committee will cut the target federal funds rate half a percentage point, to 2.5 percent. It would be the ninth cut this year. On Jan. 1, the federal funds rate was 6.5 percent.
“I think that the Fed really wants to take a stance to insure that confidence does not erode too much, to ensure that there’s enough liquidity in the economy,” says Celia Chen, senior economist for Economy.com. She expects a half-point cut. “I think a lot of it is symbolic, as well as a practical attempt to make the economy a little stronger.”
Symbolism for some
A rate decrease would be partly symbolic because many consumers aren’t going to benefit directly from it. About one-third of American adults don’t have credit cards, and many of the rest have
credit cards with minimum interest rates. Lots of those folks have already reached their cards’ minimum interest rates, so those rates won’t drop any further.
General Motors, Ford and DaimlerChrysler already offer 0 percent financing for qualified buyers. If you qualify for a 0 percent auto loan, a Fed rate cut won’t make your payments any lower. On the other hand, if you don’t qualify for a 0 percent auto loan, or you would rather buy a used or foreign-made car, maybe the Fed’s cut will save you a few dollars a month. Or maybe you’ll buy a slightly more expensive car.
The rates on home equity lines of credit might drop, but most HELOC borrowers have minimum monthly payments. They won’t necessarily have more cash to burn because they’ll still have those minimum payments.
And long-term rates on mortgages respond to bond markets, not to short-term interest rates influenced by Fed actions. Whatever the Fed does Tuesday, its action won’t directly affect rates on 30-year fixed mortgages.
Of course, some people will see decreases in their credit card interest rates, and some HELOC borrowers will save money. A Fed rate cut would put more cash in their wallets. Will they spend it? Or will they save it or pay off their credit cards faster in case they lose their jobs?
Putting more money in your hands
Many, but not all, economists believe the U.S. economy is in recession — defined as six months during which we produce less goods and services than before. They believe that the contraction began before Sept. 11. Since consumer spending accounts for two-thirds of the economy, the first step to getting out of a recession is to put more money in consumers’ hands.
You have to wonder, though, what good that will do right now. Economic forecaster George Perry put it succinctly Wednesday at a forum sponsored by the Brookings Institution: “I will remind you that the weakness that we already had, the pre-Sept. 11 softening of the economy, occurred in the face of seven cuts in the federal funds rate, dropping the rate from 6.5 to 3.5 percent.”
To which Alice Rivlin, a former vice chairwoman of the Fed and another participant in the Brookings forum, replied: the Fed’s rate policy has worked.
“It has worked in the sense that I think that it could have been a lot worse, at least up to Sept. 11, if we hadn’t had such an aggressive monetary policy,” she said, adding that it doesn’t matter much if the Fed cuts the rate by a quarter-point or half-point on Tuesday, “except whatever psychology they’re trying to project.”
If all economists agreed, there would be need for only one economist. While Rivlin thinks the Fed has played its cards right, Michael Cosgrove, an economist and principal at The Econoclast, an economic research firm, believes that the Fed hasn’t done enough.
The 2 percent solution?
The Open Market Committee should reduce the federal funds rate by a half-point now, he says, and another half-point by year’s end. That would bring the rate down to 2 percent, add lots more money to the economy, and encourage investors to put their money into stocks again, he says.
That’s not enough, Cosgrove believes: “The Federal Reserve and Congress need to get out in front of this.” He thinks Congress should accelerate planned cuts in personal income taxes to get more cash in people’s hands.
“Help the consumer,” Cosgrove counsels. “Consumers will have more income, and that will encourage the consumer to spend.”
A rate decrease won’t necessarily help one class of consumers: Retirees who save money in certificates of deposit. Rates for six-month, one-year and five-year
CDs are at their lowest point in at least 17 years.
The federal funds rate is the interest rate that banks charge one another for overnight loans to meet their required cash reserves. The Federal Reserve doesn’t directly control the rate, but sets a target and then influences the rate by buying and selling Treasury securities.