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Fed Cuts Rate Again in Latest Bid to Shore Up Economy

The Federal Reserve cut a key interest rate by a quarter point Wednesday, bringing the federal funds rate down to its lowest level since late 2004. The move is intended to help address the ongoing housing slump and credit crunch. Analysts discuss the Fed's action and the economic strain on the American public.

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    The weakening economy and its impact is where we begin tonight. And it was the main reason the Federal Reserve decided to cut interest rates again today, the seventh time in as many months.

    Greg Ip covers the Fed for the Wall Street Journal, and he joins me now.

    Greg, it's good to see you again.

  • GREG IP, Wall Street Journal:

    Hi, Judy.


    They were expected to cut rate. They did. Why?

  • GREG IP:

    Well, because, Judy, as you said yourself, the economy is quite weak. We just heard from the Commerce Department today that, in the first quarter, the economy only grew at an annual rate of 0.6 percent. That's about the same rate it grew at in the fourth quarter of last year.

    And you put those two together, it's the weakest period for the economy since 2001 when we were in recession. And it could get worse.

    Home prices continue to decline. And it's very difficult for people who want to buy a home to even get a loan because banks are so reluctant to make new loans.

    And on top of that, we have the oil price well over $100. That's eating into consumers' purchasing power. You put all that together, and it's clear that there are still significant risks to the economy.


    Why a quarter of a percent cut? Why not more than that?

  • GREG IP:

    Well, because, Judy, the Fed feels that they're actually getting to the end of the amount of rate-cutting that they feel they have to do. You have to put this in context. It is the seventh rate cut.

    When you add it to the others that they've done, since August they've brought their main interest rate down by 3.25 percentage points. That's dramatic. It's even faster than Alan Greenspan brought the rate down in 2001 when he was chairman and inflation was a lot lower at the time. In fact, the rate right now is well below the inflation rate.

    And it's occurring against a backdrop when there are those who feel the Fed has perhaps cut it too much.

    And so, importantly, in a statement that they released today with their rate cut announcement, they gave us strong hints that they will not be cutting it again, unless there's an unexpected downturn in the economic outlook.


    This was the language wherein they removed this sentence that they had had before about being concerned about downside risk to growth?

  • GREG IP:

    That's right, Judy. And reading the Fed is a bit like reading the Kremlin in the old days. There's as much significance in what they don't say as what they do say.

    So for some months now, they have been saying that there were downside risks to growth, which was code for, "We're inclined to lower interest rates again." They took that sentence out, which is code for, "We think we're going to sit here for a little while and see if all the stuff we've already done has the beneficial impact that we expect for the economy."


    Now, what have they seen? What do we think is the tipping — what tipped the balance here for them? What caused them to change?

  • GREG IP:

    Well, I think a couple of things. One was just the cumulative stuff they've done so far, the number of rate cuts, the fact that we'll have over $100 billion in tax rebates going out very soon, and they've also had a couple of unorthodox moves basically designed to get more cash out to the banks and the securities dealers in hopes they will use that money to lend more.

    And there have been signs of improvement in the financial markets, which has been the locus of the crisis that's probably driven the economy into recession. Stock prices are up about 9 percent since their low in early March.

    And the rates on risky types of bonds, such as those backed by mortgages and the bonds issued by corporations, have come down quite significantly when you compare them to super-safe treasury bonds.

    That kind of decline in borrowing costs is a sign that lenders and investors are tiptoeing back into the markets and recovering some of their appetite for risk. And that's a necessary condition for the economy to put this weak spot behind it.


    Now, we saw they did make it known that two of the Federal Reserve governors voted against this rate cut. What's behind that?

  • GREG IP:

    Well, that's a reflection of many of the concerns on the other side of the Fed's job that they have to worry about, because the Fed's job isn't just to maintain full employment but to also maintain stable prices.

    And the fact of the matter is that inflation has been running at about 4 percent for some time now, which is well above anybody's definition of stable prices. And what you have is some officials at the Fed who believe the Fed has concentrated too much on the risks to unemployment and not enough on the risks to inflation.

    Now, the main view at the Fed of Chairman Ben Bernanke is that the rise in inflation we've experienced in the last year is temporary. Once oil and food prices stop going up, which is the bet of the most knowledgeable authorities, then inflation will come back down.

    After all, you have unemployment going up, and it's very difficult for wages to go up in that sort of situation. And you kind of need that to happen to get a wage price spiral. But you can't take that for granted.

    In particular, it's of great concern to Mr. Bernanke and his colleagues that inflation expectations have risen, which means that, if you look at the way investors and the public behave, they've begun to think that inflation will stay at these levels.

    And the big risk is that they then build that into their own behavior when they're negotiating prices and wages and what we think is a temporary increase in inflation will become permanent.


    All right. Well, giving us a bit of a road map, Greg Ip with the Wall Street Journal. Thanks very much.

  • GREG IP:

    Thank you, Judy.