Fed cuts a half point

Central bank slashes key rate again as economy stalls in 4Q

January 31, 2008|By Kevin G. Hall | Kevin G. Hall,McClatchy-Tribune

WASHINGTON -- Armed with new evidence indicating that U.S. economic growth virtually stalled late last year, the Federal Reserve announced yesterday another half-point cut to a key lending rate in a bid to keep the economy out of recession.

The Fed reduced its benchmark federal funds rate - the overnight rate that banks charge each other - to 3 percent. In just eight days, the central bank chopped its benchmark rate by 1.25 percentage points, emphasizing its concerns that the U.S. economy is going into a near stall.

This view was underscored by Commerce Department data released hours before the rate cut, which showed that the U.S. economy grew by a subpar 2.2 percent in 2007 and a tepid 0.6 percent in the last quarter of the year.

That number was roughly half the growth rate that most mainstream economists had anticipated. It confirmed that the U.S. economy had little tail wind going into what's been a volatile start to 2008.

"Financial markets remain under considerable stress, and credit has tightened further for some businesses and households," the Fed said. "Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets."

The statement left open the possibility of more rate reductions in the months ahead.

"Today's policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain," it said.

Commercial banks mirrored the Fed's move, lowering their prime rate - what they charge their best borrowers - to 6 percent. The Fed also made a half-point cut to the rate it charges banks for emergency borrowing.

Usually, lower rates make it cheaper to take out a car loan, pay off credit card debt or buy inventory for a small business. But turbulent credit markets and a deep slump in the housing sector may mute some of the benefits of all the rate reductions, whose effects in any case won't be felt across the broader economy for months. Banks and other lenders have become reluctant to lend to anyone but borrowers with strong credit histories.

Commerce Department economic-growth data released yesterday illustrated how much housing is hurting the broader economy. Investment in residential housing fell by the largest quarterly amount since 1981, and that's dampening the Fed's efforts to stimulate the economy.

"The principal link between monetary policy and the economy is the housing market, and this link is being short-circuited by the housing recession," said Mark Zandi, the chief economist for Moody's Economy.com, a forecaster in West Chester, Pa.

Speaking in Washington to a real estate group yesterday, Treasury Secretary Henry M. Paulson Jr. warned that a housing rebound appears unlikely anytime soon.

"While a swift, simple and substantive fiscal-growth package will provide a boost and add to job creation this year, it is not intended or expected to slow down the housing correction. After years of unsustainable home-price appreciation, this is a necessary correction," he said.

President Bush and Congress are putting together an economic stimulus plan, hoping that the combination of tax rebates for consumers and tax breaks for businesses will spur consumer spending, which drives two-thirds of U.S. economic activity.

Yesterday's economic data confirm that consumer spending is slowing and that consumers have less money left over after meeting their basic needs.

Consumer spending rose by 2 percent in the fourth quarter, down from 2.8 percent in the third quarter. That level contributed 1.37 percentage points to economic growth in the fourth quarter, down from 2.01 percentage points in the third quarter. Real disposable personal income grew by just 0.3 percent, well off the 4.5 percent increase during the third quarter.

The troubled housing sector negated almost all gains from consumer spending. Investment in residential housing fell 24 percent in the fourth quarter, shaving an estimated 1.18 percentage points off the economic growth rate.

In previous quarters, growing U.S. exports had offset the negatives from housing. But in the fourth quarter, exports contributed less than half a percentage point to the economic growth rate.

The biggest surprise in yesterday's data was that business inventories fell during the last three months of 2007, in the past a harbinger of recession. But inventory management has grown more precise in recent years and the drop in inventories could signal that companies already are well positioned to operate in a slower economy.

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