Fed cuts rates a quarter point

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The Federal Reserve has cut the short-term interest rate by a quarter of a percentage point, to its lowest point since July 1961 — the month that Mercury astronaut Gus Grissom became the second American in space.

Minutes after splashdown, Grissom watched helplessly as Liberty Bell 7 sank into the Atlantic. The Fed doesn’t want to let something similar to happen to the economy.

Keeping up its yearlong policy of stimulating the economy by easing interest rates, the Fed’s Open Market Committee lowered the overnight lending rate from 2 percent to 1.75 percent. It’s the 11th time the Fed has cut the federal funds rate this year. At the beginning of 2001, the rate was 6.5 percent.

“Economic activity remains soft, with underlying inflation likely to edge lower from relatively modest levels,” the Fed said in a statement. “To be sure, weakness in demand shows signs of abating, but those signs are preliminary and tentative.”

The prime rate, which is the interest rate that banks charge their best customers, is expected to fall immediately to 4.75 percent in response to the Fed’s action. The prime rate influences the rates for auto loans, credit cards, home-equity lines of credit and other short-term debt.

The Fed’s rate cut won’t have much effect on long-term loans such as 15- and 30-year mortgages. Those rates are influenced by the interest paid on 10-year Treasury notes, which in turn are influenced by investors’ long-term expectations for the economy.

The rate cut isn’t the biggest news to come out of the Fed meeting. Ranking above the rate cut in importance is the “bias statement,” a paragraph in which the Fed says whether it thinks the economy is getting stronger, getting weaker, or on an even keel.

All year, the Fed has said it believes the economy is at risk of weakening further. That’s why it continued to cut short-term interest rates — a policy that didn’t prevent a recession, but almost surely kept the recession from getting worse.

This time, economists and investors were watching the bias statement to see if the Fed thinks the economy is about to get worse or get better. Many economists believe that the economy is about to improve.

“The economic news is no longer universally downbeat and that is giving rise to talk that the recession is possibly ended. It hasn’t,” Wachovia Securities economist David Orr says. “The fact that a few upbeat reports are beginning to surface is good news, however, and is consistent with our view that the economy will begin to recover by the spring of 2002.”

The Fed didn’t change the bias this time, saying that the recession hasn’t run its course. That means that the Open Market Committee is leaning toward cutting rates again when it meets next on Jan. 29 and 30.

Fed members had been hinting for a month that they stand ready to continue stimulating the economy. “Looking ahead, we are likely facing a period of quite sluggish economic activity,” Michael Moskow, a member of the Open Market Committee, said in November.

Other Fed officials said similar things in recent weeks, downplaying some of the good economic news that has come out recently — strong retail sales (fueled by zero-percent auto financing), rising consumer confidence, lower energy prices, a decreasing rate of layoffs.

Instead, Fed officials have pointed out that unemployment continues to rise, even as the number of layoffs falls slightly, because people can’t find jobs. The unemployment rate climbed to 5.7 percent in November, the highest in more than six years, and it’s expected to top out at more than 6 percent early next year.

Holiday sales look grim. PNC Bank chief economist Stuart Hoffman points out that “persistently high household debt burdens mean consumers will be less willing to resort to credit cards to pay for holiday spending sprees” — especially because consumers are uncertain about terrorism and the war in Afghanistan.

In this situation, it’s hard for the Fed to stimulate demand, but that’s what it’s trying to do.

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.

The Fed also lowered the seldom-used discount rate to 1.25 percent. The discount rate is the rate the Fed charges banks to borrow reserves from the Fed.

— Posted: Dec. 11, 2001