Saved by Zero? Fed Slashes Rate to Historic Low

Dec. 16, 2008 — -- In a bid to bolster the country's ailing economy, the Federal Reserve System is cutting its benchmark interest rate to its lowest level ever.

The Fed's Open Market Committee announced this afternoon that it is setting the target at a range from 0 to 0.25 percent. The move marks the first time the Fed has set a range instead of a single target.

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The historic decision was paired with pledges by the Fed to "employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability," including injecting more money into the lending markets.

The news drove a three-digit rally on Wall Street, with the Dow Jones industrial average spiking about 360 points.

In a statement explaining the Open Market Committee's decision, the Federal Reserve cited faltering economic conditions.

"Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further," the Fed said.

The statement stressed the other actions the Fed is taking to boost the economy, including buying mortgage-backed securities and other asset-backed securities.

"The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity," the Fed said.

The rate cut was greater than what many analysts had predicted. But the Fed's emphasis on its other tools -- lending and loan-buying programs -- echoed what economists had been saying before today's announcement: that the Fed's ability to set the key federal funds rate -- once the Fed's main instrument for shaping monetary policy -- is now overshadowed by its expanding lending powers.

"They've moved away from the period where it's the interest rate that matters to it's the size and the composition of the balance sheet that matters," said Vincent Reinhart, a former director of the Federal Reserve Board's division of monetary affairs and a resident scholar at the American Enterprise Institute.

The Federal Reserve's balance sheet has mushroomed to more than $2.2 trillion from just less than $900 million in early September. The surge reflects efforts by the Fed to inject money into frozen credit markets -- and ultimately encourage bank lending to businesses and consumers -- through a spate of new lending facilities.

These include a program to buy commercial paper, a type of corporate debt that can be used to finance day-to-day business operations, and a $600 billion program to buy new mortgage-backed securities and debt from mortgage giants Fannie Mae and Freddie Mac as well as two other government housing finance agencies.

"The Fed has moved to what they call quantitative easing policies, which is generally defined as anything other than [changing] the Federal Funds rate," said David Wyss, managing director and chief economist at Standard & Poor's. "They're seeing things locked up and therefore they're intervening."

But the Fed's injections, Wyss said, shouldn't last forever. Eventually, after Americans start spending money again, the Fed will have to "drain" its cash from the market to avoid inflation, he said.