News > Economy
Fed cuts rates a quarter point
graphic December 11, 2001: 4:01 p.m. ET

U.S. central bank brings short-term rates to lowest level in 40 years.
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  • What lower rates mean for you - Dec. 11, 2001
  • Store sales disappoint - Dec. 11, 2001
  • Unemployment highest in six years - Dec. 7, 2001
  • GDP revised to wider 3Q decline - Nov. 30, 2001
  • Economists say recession began in March - Nov. 26, 2001
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  • Fed statement
    NEW YORK (CNN/Money) - The Federal Reserve cut interest rates by a quarter-percentage point Tuesday and indicated that while it saw possible hints of a recovery in the United States, it was ready to cut rates again to help prop up the world's largest economy.

    The nation's central bank said it cut its target for the federal funds rate to 1.75 percent from 2.0 percent, bringing the rate that banks charge each other for short-term loans to its lowest level in about 40 years. The Fed also cut the symbolic discount rate by a quarter percentage point to 1.25 percent.

    The cuts - the 11th by the Fed this year and the fourth since the Sept. 11 attacks - set a record for the most in a year by the central bank and were in line with what most Wall Street economists had forecast.

    In the closely watched statement accompanying its decision, the Fed signaled it was leaning toward cutting rates again, saying there still were risks to the health of the world's largest economy.

    "The (Fed's policy making) Committee continues to believe that, against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future," the Fed said in its statement.

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      graphic CNNfn's Louise Schiavone reports on the Fed's rate cut.

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    On Wall Street, investors drew hope from the cut and the Fed's statement, but stocks ended mixed after a profit warning from Merck, the nation's largest drugmaker, pulled the Dow Jones industrial average lower. Treasury bond prices rose after the rate cut.

    Investors and analysts were mostly divided about the Fed's declaration that "weakness in demand shows signs of abating, but those signs are preliminary and tentative." Some investors interpreted that to mean the Fed might be done cutting rates for now.

    "This is the first official acknowledgment that the economy is beginning to improve," said Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd., whom the Wall Street Journal cited Tuesday as being a rare optimist about a quick economic rebound.

    Others noted that the Fed's calling signs of improvement "preliminary and tentative" was hardly a gung-ho rallying cry.

    "The Fed really tried to throw some cold water on those who are saying the recession's over already," Alan Blinder, a Princeton economics professor and former Fed Vice Chairman, told CNNfn's Money Gang program. "The optimists are declaring it over already ... I think there's a good chance they're wrong, and the Fed obviously is predicating policy on the basis that they are wrong."

    Click here for more on the Fed and rates

    U.S. gross domestic product (GDP) shrank in the third quarter, meaning the economy is half the way to a recession, as commonly defined. Economists at the National Bureau of Economic Research said recently that a recession began in March.

    The 11 Fed cuts in response to the weakness are the most in any calendar year since the Fed started targeting the federal funds rate as a key instrument of monetary policy in the 1970s. The target rate stood at 6.5 percent at the start of the year and is now at levels last seen in 1961.

    Four of the cuts have come since the Sept. 11 terrorist attacks severely disrupted and delayed a possible recovery in the economy after a slowdown lasting more than a year.

    That slowdown started after the Internet technology stock "bubble" burst last year, due in part to higher energy prices and six Fed rate hikes between 1999 and 2000. That led to a recession in manufacturing as production slowed while companies tried to get rid of stockpiles of unsold goods. That in turn led to hundreds of thousands of job cuts.

    At the same time, consumer spending and confidence stayed relatively high, and economists thought a recession was avoidable -- until Sept. 11. After that, consumer confidence fell and job cuts soared, with the unemployment rate hitting a six-year high of 5.7 percent in November.

    That report made another rate cut almost certain, economists said. With unemployment expected to keep rising even if the economy begins to recover - which many economists think is likely next year - the Fed might be ready to cut rates one more time to help encourage consumers worried about pink slips.

    "The jobless rate is the best indicator of monetary policy," said Sung Won Sohn, chief economist at Wells Fargo & Co. "The Fed keeps cutting rates as long as the jobless rate goes up. This time around is really no exception."

    The Fed will also keep a close eye on consumer spending, which fuels two-thirds of the U.S. GDP, the broadest measure of economic growth. Retail sales, one key measure of consumers' willingness to buy, have been disappointing so far in the crucial holiday season.

    "The Fed is now very much in a data-dependent mode, and the incoming data are going to dictate the decision," former Fed Vice Chairman Blinder said. "They're going to be watching the indicators of spending."

    Click here for more on what rate cuts mean for you

    Consumer spending is the part of the economy most sensitive to Fed rate cuts, since they make borrowing money easier. Immediately after the Fed's announcement, in fact, M&T Bank Corp. (MTB: up $0.75 to $73.60, Research, Estimates) cut its prime lending rate, and other banks are expected to follow suit.

    The Fed's job is complicated by a slowdown in growth around the world. Japan, the world's No. 2 economy, is in another recession, growth is sluggish in Europe, and in Latin America Argentina is struggling to avoid default on its $130 billion of debt.

    The central bank also has to keep in mind the impact of an economic stimulus package from Congress - if one ever comes. The House passed a plan weeks ago, focused mostly on tax breaks for corporations. Democrats, who control the Senate, would prefer to give money directly to unemployed workers.

    President Bush and lawmakers have been working on a compromise before Congress' holiday recess. Many on Wall Street are hungry for some kind of fiscal stimulus; but that, combined with aggressive Fed rate cuts, low energy prices, and deficit spending by the government could fuel inflation in the long term.

    For now, however, inflation is a distant threat and is even "likely to edge lower," according to the Fed's statement. graphic


    What lower rates mean for you - Dec. 11, 2001

    Store sales disappoint - Dec. 11, 2001

    Unemployment highest in six years - Dec. 7, 2001

    GDP revised to wider 3Q decline - Nov. 30, 2001

    Economists say recession began in March - Nov. 26, 2001


    Fed statement