Fed Slashes Rates Yet Again in October

The Federal Reserve slashed short-term interest rates by another half-point today, bringing them to the lowest levels since the Kennedy administration, in an effort to boost consumer and business spending and revive the downtrodden economy.

The Fed's policy setting arm, the Federal Open Market Committee, lowered its benchmark federal funds rate by a half percentage point to 2.50 percent, its lowest since May 1962. It also lowered the more symbolic discount rate by a half-point to 2 percent.

Several major banks immediately followed the Fed's lead and lowered their prime lending rate to 5.5 percent from 6 percent. M&T Bank, Bank of America and FleetBoston Financial acted immediately, with other banks likely to follow suit.

"The terrorist attacks have significantly heightened uncertainty in an economy that was already weak," the Fed said in its accompanying statement. "Business and household spending as a consequence are being further damped. Nonetheless, the long-term prospects for productivity growth and the economy remain favorable and should become evident once the unusual forces restraining demand abate."

Financial markets registered a positive reaction to the move, with the Dow Jones industrial average climbing more than 110 points and the Nasdaq composite index ending the day in positive territory.

"Markets expected it. Everyone expected it. The Fed did it. It's needed," said Alan Sinai, an economist with Decision Economics in Boston. "The real question now is how much more, if anything, the Federal Reserve will do."

Cutting Rates Aggressively

Prior to today's decision there was virtually unanimous consent on Wall Street that the economy needed another shot in the arm. Even before Sept. 11, the Fed was cutting rates aggressively in an effort to encourage consumers and businesses to borrow.

After last month's terror attacks that all but shuttered the U.S. economy and financial markets for a week, the Fed stepped in with a half-point cut on Sept. 17 to stimulate growth — and confidence.

But what remains uncertain is what kind of impact all these rate cuts might have on the fragile economy, which is experiencing an unprecedented amount of uncertainty as Americans brace for the possibility of further attacks at home and war abroad. And it is equally unclear how government spending in the form of tax cuts, bailouts and other incentives will work to pull the economy out of its funk.

Normally, the Fed lowers the overnight rate to push down the cost of consumer and business loans, stimulating purchases and boosting growth. The change generally trickles through financial markets and eventually to consumers by bringing rates on medium- and long-term bonds down — rates that are directly tied to consumer borrowing.

But these are not normal times. Even as the Fed has pushed its rate lower, the yield on the 10-year Treasury note, to which many mortgage and business loans are tied, has fallen only a half percentage point. The average rate on a fixed, 30-year mortgage was only about a quarter point lower than at the start of the year.

No Incentive to Borrow

The reason is that investors are not as keen to purchase long-term U.S. investments at the moment. And with long-term rates little changed, businesses haven't been encouraged to borrow, leaving the overall economy treading water.

"The Fed probably will continue easing until it has clear evidence of a self-sustaining recovery," said Salomon Smith Barney chief economist Kermit Schoenholtz.

Before Sept. 11, consumer demand was the saving grace to the economy's woes. Despite prevalent signs of economic weakness, consumers continued to spend on cars, homes, vacations and other peripherals that helped keep growth on the plus side through the second quarter of the year. Even then, there were questions as to how much longer the consumer could keep things going.

Unfortunately, the attacks definitively dealt with that. The U.S. economy, already struggling in the second quarter, probably shrank in the just-ended third quarter and is likely to do so in the fourth after the attacks depressed consumer and business spending, according to most analysts' predictions.

Today, President Bush's economic adviser, R. Glenn Hubbard, became the first administration official to forecast the nation's first recession in more than a decade. The textbook definition of recession is two consecutive quarters of negative growth.

Quagmire for the Fed

All that has left Greenspan and his fellow central bankers in a bit of a quagmire: Do they continue cutting rates, knowing the impact of each reduction takes anywhere from nine to 12 months to take effect, or do they sit back and wait for their previous rate cuts as well as various initiatives currently being pondered by Congress to kick in?

While most agree the added measures will work, not everyone agrees on how much is really needed or when the effects will make themselves known.

"The Sept. 11 attacks were an unprecedented shock to the system, but there's no doubt in our mind that this massive stimulus will work, promoting recovery by mid-2002 or sooner," said Steve Slifer, chief economist with Lehman Brothers. "The issue seems to be exactly what kind of combination of monetary and fiscal stimulus will spur that to happen, and when."

But William Dunkelberg, chief economist for the National Federation of Independent Business, sees things a little differently. "There's enough stew in the pot, we just have to bring it to a boil and see what it tastes like," he said, adding that he doesn't think the Fed should be lowering rates at all.