Fed slashes benchmark interest rate to record low
Federal Reserve drops key rate to lowest point in history
By Jeremy M. Simon | Updated: January 28, 2009
See latest story: Federal Reserve, out of ammo, invents new ways to stimulate economy
In what was largely a symbolic move, the Federal Reserve today cut a key short-term interest rate to its lowest level in history. That decision is not expected to have much impact on annual percentage rates for credit cards.
|Fed cuts interest rates|
Source: CreditCards.com rate report, Federal Reserve
The Fed's rate-setting group, the Federal Open Markets Committee, cut the target for the benchmark federal funds rate to a range of 0 percent to 0.25 percent in the latest in a string of attempts by the regulator to stimulate lending and prop up the faltering economy. At the conclusion of a two-day meeting, committee members voted unanimously on Tuesday to slash the fed funds rate. Previously, the rate's all-time record low was 1 percent, hit most recently in October and before then from June 2003 to June 2004.
Today's action marked the 10th consecutive rate cut. Most recently, the central bank trimmed rates by a half percentage point on Oct. 29. Before the Fed began its campaign of rate reductions in September 2007, the federal funds rate stood at 5.25 percent.
"The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time," the Fed said in a post-meeting statement.
The federal funds rate -- the rate at which banks lend to other banks -- is important because it is used as a benchmark for other rates. Banks set their prime rates, for example, at 3 percentage points higher than the fed funds rate. In this case, banks set their prime rates 3 percentage points above the top end of that range at 3.25 percent. The prime rate, in turn, is the primary index used to set rates on some consumer loans, such as variable rate credit cards and home equity lines of credit.
But today's action was seen as symbolic because many variable rate cards have already hit rate "floors" below which they will not fall, and lenders are pulling back on and rarely extending home equity lines of credit. In addition, the flood of money the Fed has poured into the market in an effort to get lending going has had the effect of disconnecting the fed funds target rate from the real rate at which banks lend to each other. The true interbank lending rate is even lower than this record-low fed funds rate, and it has done little to stimulate consumer lending.
Analysts do not expect the Fed's latest cut to ease average percentage rates for credit cardholders. "Under normal circumstances, a reduction in the fed funds rate should result in lower credit card APRs. However, these are not normal circumstances," says Ann Owen, an economics professor at Hamilton College in Clinton, N.Y.
"Yesterday, the effective fed funds rate was 18 basis points, well below the target rate of 100 basis points," Owen says. One hundred basis points is another way of saying 1 percent, so 18 basis points amounts to 0.18 percent. "Clearly, the Fed is not hitting the target and has not been hitting the target rate for some time; the actual level of the target fed funds rate is a bit irrelevant." Because of this, Owen notes, it is difficult to argue that today's rate cut has anything other than symbolic value for the immediate future.
Under normal circumstances, a reduction in the fed funds rate should result in lower credit card APRs. However, these are not normal circumstances.
|-- Ann Owen
Economics professor, Hamilton College
Fed considers new options
Since the option of additional rate cuts as a means of stimulating the economy is essentially used up, the Fed may weigh other strategies for injecting liquidity, including printing money or buying up debt. "One of the strategies that the Fed mentions is that the FOMC will be evaluating purchasing long-term Treasury securities as a way of lowering long term rates to stimulate the economy," Owen says. "This is a new tool in the monetary policy arsenal that it has not used yet."
The consideration of those possibilities "means there are no options that are not on the table, even if they are wildly divergent and diametrically opposed," says Elizabeth Rowe, director of banking advisory services with Mercator Advisory Group in Maynard, Mass.
Both of those choices could prove unnerving to the market. When it comes to printing money, "That is the last tool that the Federal Reserve has," Rowe says. She adds that the central bank would likely wait until any economic stimulus from the new Obama administration is introduced before taking that step. As for providing liquidity via such options as buying Treasury bonds, "This is not the right time for the government to think about retiring debt," Rowe says.
If the Fed does begin printing money, Rowe says cardholders should remain confident that any resulting inflationary pressure would not translate into higher interest rates as lenders work to make up the difference from the value of the borrowed funds. "If there is this new flood of printed money into the economy, which would be an inflationary force, banks would be very hesitant to raise consumer interest rates to mirror those rates of inflation," she says.
With the government closely watching lenders as it tries to reboot the economy, "consumers can feel fairly confident that punitive rate-setting is not going to be coming from the credit card industry," Rowe says. "They are in a little bit of hot water, and their arrogance is being scrutinized in a way that the banking industry doesn't like."
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