low can Fed go on interest rates?
Washington - Just how far will the Federal Reserve go in
lowering interest rates to save the country from a long
and painful recession?
key rate from the current 1 percent all the way down to
zero can't be ruled out. But there are risks in taking such
an unprecedented step: namely, that it wouldn't work in
turning around the economy and breaking through a stubborn
zero percent rate - virtually "free" money - could
trigger a speculative investment frenzy that could feed
a bubble that pops, wreaking havoc on the economy. And that,
in turn, could lead to the very kind of financial crisis
now afflicting the global economy. Former Fed Chairman Alan
Greenspan - now partly blamed for the current problems -
has called today's crisis a "once-in-a-century credit
Emphatic as it
was, the bold rate reduction the Fed ordered Wednesday and
the possibility of even lower rates ahead are no panacea.
Even lower rates won't necessarily entice skittish Americans
to spend and squeezed banks to lend more freely - forces
at the heart of the economic woes.
With any luck,
though, the Fed's action will cushion the blow to the country,
which is on the brink of - or already in - its first recession
The Fed slashed
its key rate by half a percentage point to 1 percent, a
rate not seen since 2003 and part of 2004. The rate hasn't
been lower since 1958.
In a gloomier
assessment of the economy, Fed policymakers said "the
pace of economic activity appears to have slowed markedly"
as consumers and businesses cut back on spending, and economic
slowdowns in other countries sap demand for U.S. exports,
which have helped keep the economy afloat.
"intensification of financial market turmoil"
is likely to weigh on consumers and businesses, further
reducing their ability to borrow money, the Fed said.
the Fed's sense of urgency is this fact: It took just 13
months for Fed Chairman Ben Bernanke, a student of the Great
Depression, to ratchet down rates to the 1 percent mark.
It took his predecessor, Greenspan, 2 1/2 years.
predict Fed policymakers will drop the rate again to half
a percentage point, which would mark an all-time low, on
or before Dec. 16 - its last scheduled meeting of the year.
The Fed left the door wide open to more rate cuts, pledging
to "act as needed" to revive the economy.
in a crisis situation and everything is on the table,"
said Richard Yamarone, an economist at Argus Research. "If
conditions deteriorate considerably, the Fed could go down
to zero. It is absolutely a possibility, but I don't believe
it is likely."
Yet even if the
Fed were to lower its key rate to zero, that might not reverse
the bunker mentality of consumers and lead them to ramp
More than in
recent recessions, consumers have retrenched as vanishing
jobs, shrinking paychecks and nest eggs, and sinking home
values have made them feel less wealthy and less inclined
to spend. Consumer spending - the single biggest chunk of
overall economic activity - probably fell in the July-to-September
quarter. That would mark the first quarterly drop since
late 1991, when the country was emerging from a recession.
And just because
borrowing costs are cheaper doesn't mean banks will feel
more inclined to beef up lending to people and businesses.
is not the interest rate," said Sean Snaith, an economics
professor at the University of Central Florida. "It
is that no one is willing to loan, regardless of what the
rate is. Lower rates will not make the problem go away.
The credit crunch will take time to resolve. This is another
action to just chip away at the gridlock in this economy,
but we shouldn't expect a miraculous turn of events from
The Fed's move
Wednesday meant the prime lending rate for home equity loans,
certain credit cards and other consumer loans dropped to
4 percent. Even if the Fed were to cut its main rate to
zero, the prime rate would fall to 3 percent but no lower.
The Fed's previous
rate reductions, in fact, were blunted by the credit crunch.
The Fed slashed rates by a whopping 3.25 percentage points
between September 2007 and April 2008, one of the most aggressive
campaigns in decades. Just a few weeks ago, the Fed lowered
rates again in a coordinated action with other central banks
around the world.
The Fed probably
would want to stop short of zero, so it saves precious ammunition
- meaning additional rate cuts - should the economy take
a turn for the worse later on, some economists said.
the Fed would want to avoid the fate of Japan, which failed
to revive its economy even after its central bank slashed
rates to zero in 1999 and kept them there for six years
before bumping them up again. Japan became mired in a decade
of lost growth in the 1990s after real-estate prices collapsed.
That caused a severe bout of deflation, which is a destabilizing
drop in prices.
rates to zero is a fairly desperate measure, and a lot of
stigma is attached to it," Snaith said. "It would
bring on comparisons to Japan."
the worry that dropping rates to all-time lows would feed
the type of speculative boom and painful bust that the country
is now suffering through. Greenspan lowered rates to 1 percent
in summer 2003 as he sought to aid the economy's slow recovery
from the 2001 recession and fend off a remote - but dangerous
- risk of deflation. He kept rates at that historically
low level for a year.
that those low rate fed the housing bubble and lax lending
standards that eventually burst and imperiled the economy.
The meltdown drove up foreclosures and forced financial
companies to rack up huge losses on soured mortgage investments,
laying low storied Wall Street firms and causing banks to
Instead of dropping
rates to zero, the Fed probably will turn to other weapons
to battle the crisis.
The Fed has already
created first-of-its-kind programs, such as getting cash
directly to companies by buying up mounds of "commercial
paper," the short-term debt firms use to pay everyday
expenses such as payroll and supplies. That program, which
started Monday, is helping to relieve credit stresses, economists
said. The Fed also is providing loans to banks, has moved
to provide a financial backstop to the mutual fund industry
and has injected billions of dollars in financial markets
here and abroad.
The Fed could
opt to expand programs by enlarging loans it's now making,
providing loans to other types of companies, or buying more
and different types of debt. The Fed's balance sheet has
doubled to $1.8 trillion in recent months, reflecting those
other activities to get credit flowing again.
Because the Fed
has wide latitude in these areas, many economists believe
Fed policymakers are more likely to continue this route
than to lower its key rate to zero.
No matter the
relief tactics, though, the economy is due for more pain.
The unemployment rate, now 6.1 percent, could hit 8 percent
or higher by next year. Home prices are likely to keep sinking
for some time, and nest eggs will continue to be battered.
in pain, and it will get more much severe over the next
six months," predicted Mark Zandi, chief economist
at Moody's (nyse: MCO - news - people ) Economy.com. "The
economic damage of the financial panic has already been
done, and the Fed is trying to limit the damage as best
AP Economics Writer Jeannine Aversa has covered the Federal
Reserve and the economy since 1999.