TOPICS > Economy

Fed Cuts Key Interest Rate Again in Bid to Avert Economic Anxieties

January 30, 2008 at 6:25 PM EST
Loading the player...
The Federal Reserve lowered its benchmark interest rate by half a point Wednesday -- the second rate reduction in eight days in a bid to help ease pressure on jittery financial markets. Wall Street Journal economics editor David Wessel examines the Fed's latest move.
LISTEN SEE PODCASTS

TRANSCRIPT

JIM LEHRER: And now, the Federal Reserve cuts rates again. Ray Suarez has that story.

RAY SUAREZ: The Fed’s decision to lower its benchmark rate twice in eight days ranks among its boldest series of action in two decades.

Today’s cut follows other news pointing to a slowdown, including a report showing the economy growing at its slowest rate in five years; soaring foreclosure filings, up 75 percent last year; and sales of new homes dropping to their lowest level in 12 years in December.

For more on the Fed’s decision, we turn again to David Wessel, economics editor for the Wall Street Journal.

And, David, does 0.5 percent constitute a significant cut, coming as it does on the heels of last week’s 0.75 percent cut?

DAVID WESSEL, Wall Street Journal: Well, the combination is what’s really significant. This is an extraordinary amount of easing by the Federal Reserve in a very short period of time. It suggests that they really are quite concerned about the economy and are determined to provide this medicine in anticipation of a recession, which may not even have arrived yet.

RAY SUAREZ: When the markets opened this morning, everybody was talking about whether it was going to be a quarter-point or a half-point. What did the Federal Open Market Committee say about its reasons for opting for the higher cut?

DAVID WESSEL: Well, at the end of every meeting, they issue a statement, and they spend a substantial amount of time thinking about what message they want to send. In this case, they pointed to four things.

They said there was still stress in the financial markets. They said credit conditions were tightening, harder for businesses and consumers to get loans, or they have to pay more for them. They pointed to a softening labor market. And they pointed, again, to the plunging price of homes.

Those are the four things they cited. And they made clear that they see, as they put it, downside risks going ahead, that they expect to keep cutting rates through the rest of this year.

Immediate and long-term impacts

David Wessel
Wall Street Journal
The Federal Reserve sets ... a benchmark, and a lot of rates are tied to the rates that the Fed sets. So people who have adjustable rate mortgages or home equity lines or sometimes variable rate credit cards, they see an immediate impact.

RAY SUAREZ: When this key rate changes so much in such a short time, what happens mechanically inside the economy? What changes about borrowing money in the really near term?

DAVID WESSEL: Right, well, the Federal Reserve sets, as you said, a benchmark, and a lot of rates are tied to the rates that the Fed sets. So people who have adjustable rate mortgages or home equity lines or sometimes variable rate credit cards, they see an immediate impact. The banks today lowered the prime rate, which is used for some of their rates.

Over time, they hope that it will make it more attractive for people to borrow. Recently, for instance, mortgage rates have been coming down, and people have been refinancing again. And so they hope that, over time, this will stimulate borrowing, stimulate spending, and offset some of the depressing parts of the economy.

RAY SUAREZ: Are the volatile securities markets in New York, elsewhere in the world, putting pressure on the Fed to make a move like this? Is it somewhat reactive to the markets?

DAVID WESSEL: Well, you know, they're in a really awkward position now, because last week's move, which came when the European markets and the Asian markets were falling and the U.S. markets were closed for Martin Luther King Day, the Fed met last Monday night, decided to cut rates before the U.S. markets opened on Tuesday.

That has a lot of people saying that the perception, anyways, is that they're reacting too much to the stock market. Their response is they do worry about the stock market because it has an effect on the economy, but what's basically motivating them is a sense that the economy was deteriorating faster than they anticipated, and they're trying to prevent a really deep recession.

Portraying air of stability

David Wessel
Wall Street Journal
The combination of the Fed moving so dramatically and the president and the Congress doing this fiscal stimulus I think is giving people a little bit of confidence that the managers of the economy are on the ball.

RAY SUAREZ: Are markets so sensitive to this kind of thing that cutting so much in a short time may signal to them that the Fed thinks things are pretty bad down the road?

DAVID WESSEL: That's always a dilemma, I think, that the Fed has. You know, the Fed has two jobs. One is to move interest rates the right way at the right time, and the other is to look like it knows what it's doing. And sometimes having an air of panic can be unproductive.

I think for now they've managed that pretty well, but that's something they always have to think about. I think that the markets want to know, though, as most of using do, that there are sort of grown-ups in charge of the economy and, if things aren't going well, they'll rush to action.

And the combination of the Fed moving so dramatically and the president and the Congress doing this fiscal stimulus I think is giving people a little bit of confidence that the managers of the economy are on the ball.

Assessing effects of past rate cuts

David Wessel
Wall Street Journal
I think there are some things to worry about. One thing is that we have this almost panic on Wall Street, these big firms that may be reluctant to lend at any interest rate, while they sort of get their act together.

RAY SUAREZ: If you look at the graphs of the interest rate changes during the Greenspan years, you'll see tiny, incremental shifts up when they wanted to tighten the access to money, and then tighten -- very small ratchets down when they wanted to loosen it.

If you resort to the tool of lowering interest rates too often, or very often, does it become a less useful thing down the road? Can you not go there if the economy continues to remain weak?

DAVID WESSEL: I don't think that's a big concern. There were times when Mr. Greenspan moved pretty quickly in 2001, as I recall. They did a couple of really sharp interest rate moves, about 1.5 percent in a relatively small period of time.

The Fed's key rate is now at 3 percent. That's a long way from 0 percent. A couple of years ago, they moved it all the way to 1 percent and held it there for a while. So they have plenty of ammunition left.

RAY SUAREZ: Well, you mentioned there are times that are similar to these. Did it work the last time this kind of loosening was tried? Did it get the response that the Fed seems to be looking for in this move?

DAVID WESSEL: It always works. The question is, how much does it work and how quickly?

So another way to answer your question is to say, what makes this time different? And will the market and the economy be less sensitive to interest rate cuts?

And I think there are some things to worry about. One thing is that we have this almost panic on Wall Street, these big firms that may be reluctant to lend at any interest rate, while they sort of get their act together.

Secondly, we really haven't been through a housing price plunge like this in any of our lifetimes, so that's going to change things.

And then there's the question of whether the atmosphere is different. And I think one reason that Mr. Bernanke endorsed fiscal stimulus is he thought the interest rate medicine could use a little help from another drug, so we'll now have both drugs, like an AIDS cocktail, if you will, fighting recession.

Factoring in stimulus package

David Wessel
Wall Street Journal
The markets are anticipating the federal funds rate, the key benchmark, will fall by 0.75 percent more before the year ends.

RAY SUAREZ: I'm glad you brought up the stimulus. Very quickly, was this change made with that stimulus in mind? Does the Fed look outside its own walls when making economic moves of this kind?

DAVID WESSEL: Absolutely. They know that the stimulus is coming. They have to factor it into their forecast. And they'll adjust rates what they think given the fact that there will be another $150 billion of juice in the economy before the end of the year.

RAY SUAREZ: And the next time they meet to set rates is?

DAVID WESSEL: About six weeks. And their signal is they're going to cut again, and the markets are anticipating the federal funds rate, the key benchmark, will fall by 0.75 percent more before the year ends.

RAY SUAREZ: David Wessel, thanks a lot.

DAVID WESSEL: A pleasure.