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Fed's rate cut no guarantee the economy will break out of its funk

A television screen at the New York Stock Exchange shows the rate decision by the Federal Reserve Board on Wednesday.

Associated Press

A television screen at the New York Stock Exchange shows the rate decision by the Federal Reserve Board on Wednesday.

WASHINGTON — The Federal Reserve on Wednesday slashed a key interest rate by half a percentage point as it seeks to revive an economy hit by a long list of maladies stemming from the most severe financial crisis in decades.

But just how far will the Fed go in lowering interest rates to save the country from a long and painful recession?

Ratcheting its key rate from the current 1 percent, a rate not seen since 2003 and part of 2004, 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 credit clog.

Eventually, a 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 tsunami."

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 since 2001.

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.

Underscoring 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, 2½ years.

Many economists 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.

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.

"The problem 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 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.

Fed's rate cut no guarantee the economy will break out of its funk 10/30/08 [Last modified: Wednesday, November 3, 2010 5:58pm]

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