Fed Cuts Interest Rates by 1/2 Point
Wednesday January 30, 2:25 pm ET
By Martin Crutsinger, AP Economics Writer
Federal Reserve Reduces Federal Funds Rate by 1/2 Point to 3 Percent


WASHINGTON (AP) -- The Federal Reserve on Wednesday cut a key interest rate for the second time in just over a week, reducing the federal funds rate by a half point. It signaled that further rate cuts were possible.

The Fed action pushed the funds rate to 3 percent. It followed a three-fourths of a percentage point cut on Jan. 22, a day after financial markets around the world had plummeted on fears that the U.S. economy was heading into a recession. That decrease had been the biggest one-day move in more than two decades.

The half-point cut Wednesday followed news that the economy had slowed significantly in the final three months of last year with the gross domestic product expanding at a barely discernible pace of 0.6 percent, less than half what had been expected. The report came amid increased concern from several quarters about a possible recession.

In a brief statement explaining their decision, Federal Reserve Chairman Ben Bernanke and his colleagues said that "financial markets remain under considerable stress."

The Fed move was approved on a 9 to 1 vote. Richard Fisher, president of the Fed's Dallas regional bank, dissented, preferring no change in rates.

The rate cut marked the fifth time that the Fed has cut the funds rate since it started with a half-point cut on Sept. 18 in response to the severe credit crisis which hit global markets in August.

The latest Fed action was expected to be quickly followed by cuts in banks' prime lending rate, the benchmark rate for millions of consumer and business loans. The Fed's hope is that by making credit cheaper, it will encourage more borrowing, giving the economy a needed boost.

The Fed's half-point move met expectations of financial markets and was a bolder move than the smaller quarter-point cut that many economists had been expecting.

Even if Ben S. Bernanke, George W. Bush and Congress win the battle to avert a recession this year, they risk losing the war to strengthen the economy for the long term.

Growth will get a boost in the second half of this year as consumers spend some of the $107 billion in tax rebates passed by Congress and signed by Bush this month. The U.S. may suffer a letdown afterward as the kick from the stimulus wears off, leaving the economy vulnerable to its underlying weaknesses: a retrenching financial industry, indebted consumers and slowing productivity growth.

``This is not a one- or two-quarter phenomenon,'' says economist Neal Soss of Credit Suisse Group, who worked as an aide to former Federal Reserve Chairman Paul Volcker. ``This is not a V-shaped event. It's a slow-growth scenario.''

Fed officials see growth picking up to more than 2 percent next year as inflation ebbs to 2 percent or below. Fed Chairman Bernanke, 54, is slated to discuss the central bank's forecast in testimony to Congress Feb. 27 and 28.

So far, the Fed's deepest interest-rate cuts since 2001 haven't helped the financial markets or the economy. What they have caused is an increase in inflation expectations, with the price of gold soaring to a record $958.40 an ounce last week.....

The Federal Reserve has been cutting interest rates aggressively since September, a total of 225 basis points in less than five months. More than half of the reduction (125 basis points) in the benchmark overnight rate was delivered in an eight-day period in January.

This must mean that the Fed is throwing caution to the wind, recklessly easing in the face of rising inflation, flooding the system with money and laying the groundwork for the Next Great Inflation, right?

Wrong. There is nothing about the level of the federal funds rate per se that tells you whether policy is easy or tight. The Fed can pretty much put the interbank rate where it wants, passively providing the reserves the banking system demands.

A lower funds rate is generally associated with an easier monetary policy, a higher rate with a tighter one. But if there's tepid demand for credit, banks have little demand for reserves. In that case a low absolute funds rate may not reflect an easy policy.

The funds rate is a means to an end, a price (interest rate) used to deliver a quantity (of money). Right now, the quantity of credit the Fed is creating, the monetary base, is minimal.

The base, which consists of currency and bank reserves, is growing 1.2 percent on a year-over-year basis. With inflation running at 4.3 percent, well, you do the math on real base growth (or shrinkage as it turns out).

Sluggish base growth could mean one of two things: Either banks aren't in a position to extend new loans because of capital inadequacy, or businesses and households are borrowing less.....

In the second week of August, the short-term fixed-income sales team at JPMorgan Securities Inc. sat stunned as the trillion-dollar market for asset-backed commercial paper began to collapse.

In normal markets, JPMorgan sells $25 billion of short-term IOUs for clients daily. ``Within the span of six or seven business days, every single investor stopped buying asset-backed commercial paper tied to structured investment vehicles,'' said John Kodweis, a managing director at the New York bank.

How the Federal Reserve has responded to that credit debacle -- the worst since the savings and loan crisis of the early 1990s -- defines Chairman Ben S. Bernanke's reshaping of the world's most important central bank.

With its focus on building consensus around long-term goals and attempts to separate liquidity from broader monetary policy, Bernanke's approach evokes appreciation among some economists. He's also caused frustration among traders trying to discern his intentions.

``The chairman walked into a job that I can best describe as trial by fire,'' said Allen Sinai, president of New York- based Decision Economics Inc. Separating interest-rate policy from liquidity tools was ``absolutely brilliant,'' he said.

To critics, his failure to quickly recognize the economic impact of the market tumult exacerbated the slowdown and meant that when the Fed began cutting rates, reductions needed to be deeper and faster.....

Federal Reserve officials are wondering how long consumer-price inflation can stay in the neighborhood of 4 percent without undermining their credibility as inflation fighters.

Over the 12 months ended in March, the cost of energy in the consumer-price index shot up 17 percent and food items rose 4.5 percent. The remaining three-fourths of the index, the so-called core CPI, was up a modest 2.4 percent.

Like everybody else, Fed policy makers have been surprised by the repeated surges in world oil prices and more recently by record costs for corn, wheat, rice, soybeans and dairy products. And they have taken comfort that all that's needed to bring the overall inflation rate down is for key commodity prices to stabilize.....