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Unable to cut rates, Fed seeks new economy-boosting tools

Federal Reserve votes to leave key rate alone

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Unable to lower interest rates further, the Federal Reserve today announced plans to use other means instead to kick-start a stalling economy.

After effectively cutting its key lending rate to 0 percent at the last meeting, the Fed said it plans to hold interest rates at "exceptionally low levels" for "some time." It also reaffirmed its promise to "employ all available tools" in order to stimulate the economy and provided further details about what those other tools might include.  

Fed rates unchanged
Fed funds rates, Sept. 2007 through Jan. 2009
Source: CreditCards.com rate report, Federal Reserve

"The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant," Wednesday's statement read. The statement indicated that the Fed also remains "prepared to purchase longer-term Treasury securities" if it appears that strategy "would be particularly effective in improving conditions in private credit markets." Additionally, the Fed said it plans to implement the Term Asset-Backed Securities Loan Facility in an effort to encourage lending to both households and small businesses.   

Since the Fed can't lower interest rates any further, there will be little immediate impact on any kinds of interest rates in the wake of the announcement, says Ann Owen, an economics professor at Hamilton College in Clinton, N.Y. "The best the Fed can do is to try to manage expectations, both about the future path of interest rates and price levels," Owen says. "By communicating that it expects to keep short-term interest rates low for the foreseeable future, it can try to lower long-term rates further."

In its previous meeting, which concluded on Dec. 16, 2008, the Federal Open Markets Committee cut the target for the benchmark federal funds rate to a range of 0 percent to 0.25 percent. That decision was approved unanimously by committee members.

Previously, the rate's all-time record low was 1 percent, hit most recently in October 2008, and before then from June 2003 to June 2004. Prior to the Fed's campaign of rate reductions in September 2007, the federal funds rate stood at 5.25 percent.  

Fed changes to monetary policy alter the fed funds rate and, by extension, the prime rate, to which many credit cards are pegged. However, with the fed funds rate already effectively lowered to 0 percent and unlikely to rise amid current economic conditions, the days of the central bank altering the rate to boost the economy are temporarily over, experts say.  

What they'd really want to encourage is the banks not to be so aggressive in reducing lines.

-- Dennis Moroney   
TowerGroup research director   

"Monetary policy is done," says Susan Menke, senior financial services analyst with Mintel International in Chicago. She explains that while talk often focuses on monetary policy, "In the larger scheme of things, it's not the most important thing going on -- and now it's certainly not," Menke says. In its place, she sees another opportunity for economic recovery: "The stimulus package is it," Menke adds.   

The central bank primarily wants to encourage more auto and loan lending by banks, says Dennis Moroney, research director with TowerGroup, a research and advisory services firm. However, when it comes to credit cards, "What they'd really want to encourage is the banks not to be so aggressive in reducing lines," he says. In recent months, banks have aggressively targeted unused credit lines for cancellation and have lowered credit limits on a wide range of customers.

Card issuers have been slow to lend as they hold onto cash in an effort to protect against losses and maintain capital, Moroney explains. The Fed could also give banks some relief on the amount that lenders are required to maintain in reserves in an effort to free up cash for borrowers, he says.

While the challenge is difficult, the problem is more clear-cut. According to Menke, the Fed needs to free up credit markets. "It's a very structural recession. Money isn't moving along," she says, noting that from her office window onto The Loop in downtown Chicago, she can see a number of construction projects that have stalled due to a lack of funding. Among them, the Chicago Spire, a giant, planned skyscraper that currently amounts to nothing more than a hole in the ground, she says. "On the architecture tour, we're going to have to say, 'Here's the hole of the building that was never completed,'" Menke says.

The Fed is unlikely to change its stance for the time being. "I wouldn't imagine they are going to touch rates anytime soon," Menke says. "The economic forecasts just get gloomier and gloomier."

Published: January 28, 2009


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