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Fed cuts by half point
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November 6, 2001: 4:27 p.m. ET
The U.S. central bank acts aggressively again to fight a recession.
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NEW YORK (CNNmoney) - The Federal Reserve cut interest rates by a half-percentage point Tuesday, its tenth cut of the year and third since Sept. 11, in an effort to keep American consumers spending and boost the U.S. economy.
Though many economists think a recession is inevitable this year, the central bank's goal is not only to lower the cost of borrowing, but also to let consumers and U.S. stock markets know it's doing everything it can to keep the world's largest economy from slowing down too much.
"Today's rate cut was no surprise," said Bill Cheney, chief economist at John Hancock Financial Services. "Even the half-point cut was more or less expected. In fact, the economy is still weak enough for the Fed to feel free to keep easing."
Fed policy makers cut the central bank's target for the federal funds rate, an overnight bank lending rate already at 40-year lows, to 2.0 percent from 2.5 percent. The Fed also cut the seldom-used discount rate to 1.5 percent from 2.0 percent.
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CNNfn's Tim O'Brien reports from the Treasury Department on 10th rate cut.
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Economists widely expected the Fed to make this cut, but were uncertain about what the central bank would say about its expectations for the future health of the economy.
In the closely watched statement accompanying the decision, the Fed said it still saw weakness, rather than inflation, as the main threat to the U.S. economy, a sign that it was ready to cut rates again.
In fact, 24 of 25 of Wall Street bond dealers surveyed by Reuters expect a quarter-percentage-point rate cut to follow the Fed's next policy meeting, scheduled for Dec. 11.
"We think the Fed will continue cutting rates, although less aggressively," said Merrill Lynch economist Bruce Steinberg. "We are expecting another [quarter-point] cut at the December meeting and another cut in January, with the fed funds rate ending up at 1.5 percent."
Though the Fed left open the door for future cuts, it also continued to express optimism about the long-term outlook for the economy.
"Although the necessary reallocation of resources to enhance security may restrain advances in productivity for a time, the long-term prospects for productivity growth and the economy remain favorable and should become evident once the unusual forces restraining demand abate," the Fed said.
U.S. stock prices rose after the announcement, and interest-rate-sensitive Treasury bond prices also rose.
After the announcement, banks such as J.P. Morgan Chase Corp. (JPM: Research, Estimates), Bank One Corp. (ONE: Research, Estimates) and FleetBoston Financial Corp. (FBF: Research, Estimates) cut their prime lending rate to 5 percent from 5.5 percent, effective Wednesday. Other banks were expected to follow suit.
The Fed's aggressive cut was likely prompted by reports last week of surging unemployment, mounting job cuts and a deepening recession in the manufacturing sector. Before those data were released, many economists thought the Fed was more likely to cut by a more modest quarter-percentage point.
"Those are the numbers that confirmed in their minds that we were in recession," said Anthony Chan, chief economist at Banc One Investment Advisors.
U.S. gross domestic product (GDP), the broadest measure of the economy, fell into negative territory in the third quarter and is widely expected to be worse in the fourth quarter, meaning the common definition of a recession - two consecutive quarters of shrinking GDP - will be met.
"Moving forward, the Fed will be focused on what they can do to get us out of recession," Chan said.
Click here for more on the Fed and rates
Still, some observers fear that the Fed may be using up all its ammunition and risks putting the United States in a situation like that of the world's second-largest economy, Japan. In that country, key short-term interest rates are at zero, but the economy is still in a sharp downturn.
Most observers, however, think the United States can avoid Japan's dilemma with assistance from Congress and President Bush. Congress is discussing ways to stimulate the economy, and the House has already passed its version of a multi-billion-dollar stimulus package.
"Japan's big problem was that fiscal stimulus was not there," said Robert Macintosh, chief economist at Eaton Vance Management. "They haven't coordinated monetary policy with fiscal policy. That's what we're doing differently, and that's why we won't have the same problem."
Critics of the House package say it focuses too much on giving money to corporations, which probably won't step up production until they know people will buy their products. Critics say it doesn't do enough to encourage consumers, who fuel two-thirds of the U.S. economy, to spend.
Supporters of the House plan point out that much of the economic slowdown of the past year was mainly due to a slowdown in spending by businesses. Only after those businesses cut production, and slash hundreds of thousands of jobs, did consumer confidence begin to wither. Encourage companies to spend, supporters say, and you will fuel production and job growth.
In the end, only consumer spending, however it is spurred, can stop a recession, and consumers still face a great deal of uncertainty in the continuing war on terrorism and job security.
"Having more cash in your pocket and spending it are two different issues, and that is the crux of the current problem," said Joel Naroff, chief economist and president of Naroff Economic Advisors. "We can cut taxes, for households or businesses, but if the willingness to spend is not there, then the cash will just pile up."
Another risk of the Fed's aggressive rate-cutting, combined with the expected stimulus from Congress, is inflation. The Fed has not been concerned with inflation for some time, however, and observers point out that Fed policy is relatively flexible; the Fed can simply raise rates again to fight inflation.
Click here for CNNmoney.com's economic calendar
Though the Fed's target for short-term interest rates was actually lower than the rate of inflation as measured by the past year's 2.6-percent gain in the consumer price index (CPI), it's still well above other measures of inflation that are more important to the Fed, such as the year-over-year change in the personal consumption expenditure price index in the GDP report, which is at 1.5 percent.
"They've got more room to move, and they will move," Wayne Ayers, chief economist at FleetBoston Financial, told CNNfn's Street Sweep program. "That's what they've always done in past recessions and what they'll do again."
And Fed rate cuts usually have a delayed impact on the economy, beginning to take effect anywhere from nine to 18 months later.
"When demand does start to rebound, the Fed will have to deal with the delayed effects of a year of aggressive monetary stimulus," said John Hancock's Cheney. "Short-term rates will almost certainly have to rise faster and farther than seems credible today. Of course, this is a problem that we now feel we would enjoy facing." 
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