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Federal Reserve Plans Interest Rate Cut to Revive Economy

The Federal Reserve is expected to cut interest rates to help shore up the nation's economy. The NewsHour's Paul Solman examines the Federal Reserve's plans and what they mean for the economy.

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    Now, a closer look at what the Federal Reserve has been up to lately and what it's expected to do tomorrow. Economics correspondent Paul Solman is our guide.

  • PAUL SOLMAN, NewsHour Economics Correspondent:

    The Federal Reserve Bank of the United states, when its Open Market Committee meets tomorrow, run by Chairman Ben Bernanke, it will simply be doing its business as usual, trying to fine-tune the economy by adjusting the famous federal funds interest rate. The purpose: to keep the economy stable long term, with low inflation and high employment.

    Well-summed up in the punch bowl metaphor of a Fed chairman many years ago, the Fed's job is to take away the punch bowl when the party gets going — raising interest rates, that is, when the economy is growing too fast, to discourage people from giddy overspending or tipsy speculation which would fuel inflation — or, by contrast, when torpor takes over and the fear of recession rears its head — by spiking the economy, in effect, lowering interest rates so people will invest and spend more, and the economy won't get depressed.

    For several years, the Fed has been taking away the punch bowl, raising the Fed funds interest rate steadily from 1 percent to 5.25 percent from 2003 until the summer of 2006. Then it paused for a year.

    Tomorrow, it's expected to begin lowering that interest rate, which banks charge each other, and which gets passed onto the rest of us in our mortgages, car loans and the like. That's because the Fed's now concerned about a weakening economy, led by the housing downturn, an economy with lower spending, less investment, fewer jobs.

    Now maybe you've heard all of that before. But in the past month or so, the Fed has done something else, as well. It's actually done the job for which it was originally intended: to rescue the economy in a liquidity crisis.

    Last month, remember, U.S. and world markets were plummeting, panicking, and they're still jittery. A panic is a liquidity crisis, says economy historian John Wallis, and he adds:

    JOHN WALLIS, Professor of Economics, University of Maryland: It could be disastrous. So the Fed was explicitly designed to give the banks liquidity for their loans, so the banks could come to the Fed, sell their loans, get cash, meet their depositors, liquidity crisis over.