Bigger-than-expected reduction is latest step in fight against recession

December 17, 2008|By Maura Reynolds | Maura Reynolds,Tribune Washington Bureau

WASHINGTON - The Federal Reserve slashed its benchmark interest rate yesterday to a record low as part of its continuing battle against the financial crisis and the recession.

The central bank cut its target for the federal funds rate - the rate paid by banks to other banks for overnight loans - from 1 percent to a range of 0 percent to 0.25 percent. The Fed indicated that the rate would stay low for some time.

The reduction was bigger than expected and sent the stock market up sharply.

Implicitly conceding that the rate cut could not alone unclog the country's economic arteries, the Fed said it was prepared to expand its purchases of mortgage-backed securities and was considering buying long-term Treasury bonds.

"Today they acknowledged that the funds rate doesn't matter as much as it used to," said Vincent Reinhart, a former director of the Fed's monetary-affairs department who co-wrote a 2004 paper on zero-interest-rate policy with Fed Chairman Ben S. Bernanke.

The moves are a reflection of the extraordinarily dismal condition of the economy, which is in a deep recession marked by rising unemployment and a near-freeze of credit markets.

"Labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment and industrial production have declined," the Fed said in its statement.

"Overall, the outlook for economic activity has weakened further."

Struggling homebuilders cut back even more than expected last month, sending the construction of new houses plummeting in November by the largest amount in almost a quarter-century. New-house starts fell to a seasonally adjusted annual rate of 625,000 from a downwardly revised level of 771,000 in October, the Commerce Department said yesterday.

That is a drop of 18.9 percent, the steepest since March 1984.

Fed policymakers anticipate "that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time," the central bank said.

Since the 1990s, the Fed has set an exact target for its benchmark federal funds rate. Although the funds target rate has been 1 percent since Oct. 29, the actual rate has been much lower for weeks; it averaged 0.39 percent in November.

Yesterday marked the first time since the current interest-rate system began in the 1990s that the target was set below 1 percent.

With the economy already in a deep recession, some economists have expressed concern that, with the Fed's main interest rate dipping below 1 percent, the central bank would "run out of ammunition" to stimulate economic growth. But Bernanke has said the central bank could inject the economy with cash by buying and selling a wide range of securities.

Over time, very low interest rates can fuel inflation. But consumer prices appear to be declining at a record pace: Consumer prices fell 1.7 percent in November, largely because of a 17 percent drop in energy prices, the government said yesterday. In most parts of the United States, prices at the pump have fallen nearly $1 a gallon in the past month.

Excluding energy and food, prices were flat in November and up 2 percent over the past 12 months.

The Associated Press contributed to this article.

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