News > Economy
Fed slashes rates again
October 2, 2001: 3:21 p.m. ET

U.S. central bank makes 9th cut of year, bringing rates to 40-year lows
graphic graphic
NEW YORK (CNNfn) - The Federal Reserve cut interest rates by a half-percentage point Tuesday, bringing overnight bank lending rates to their lowest level in nearly 40 years in an effort to keep the U.S. economy from falling into a recession.

The U.S. central bank cut its target for the federal funds rate to 2.5 percent from 3.0 percent, the lowest level since 1962. The Fed also cut the seldom-used discount rate to 2.0 percent from 2.5 percent.

It was the ninth cut in 2001 and the second since the terrorist attacks on Sept. 11. Most economists think the attacks pushed the U.S. economy, already weak after a year-long slowdown in spending by businesses, into a recession. The Fed's goal is to make money more available to consumers, who drive two-thirds of America's economy, and keep them spending.

"What the Fed showed was that extraordinary circumstances require an extraordinary strategy," said Anthony Chan, chief economist at Banc One Investment Advisors. "Not only are they moving rates to lows not seen since the early '60s, they're prepared to move them a lot lower."

In the closely watched statement accompanying its rate decision, the Fed said the risks to the U.S. economy "are weighted mainly toward conditions that may generate economic weakness in the foreseeable future."

graphic   VIDEO  
graphicCNNfn's Tim O'Brien reports from Washington on Fed's half-percentage point rate cut.
Real 28K 80K
Windows Media 28K 80K
"The terrorist attacks have significantly heightened uncertainty in an economy that was already weak," the Fed statement said. "Business and household spending as a consequence are being further damped."

U.S. stock prices fell immediately after the Fed's announcement, but rebounded later in the day, while U.S. Treasury bond prices rose. Some analysts suggested stocks fell at first because investors were worried that the half-point cut and gloomy statement sent an ominous signal about the economy's health.

"That is a negative statement as far as I am concerned," said Peter Cardillo, director of research at Westfalia Investments. "That puts a negative emphasis on the economy."

But the Fed said it was positive about the long-term outlook for the world's largest economy.

"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 statement said.

Click here for more on the Fed and rates

Nevertheless, most economists expect the Fed to cut rates again by the end of the year, possibly at its next policy meeting, scheduled for Nov. 6. The size of the cut will depend on the economic data received between now and then.

Recent data hinted that the beleaguered manufacturing sector, which has borne the brunt of a year-long slowdown in the general economy, was beginning to recover before the attacks. But there have also been signs that consumer confidence was beginning to wane before the attacks, and it has certainly done so in the days since.

Though gross domestic product, the broadest measure of the economy, was positive in the second quarter, it is likely to be negative in the third, especially considering that the economy ground to a standstill in the days following the attacks. If fourth-quarter GDP is also negative, then the standard definition of a recession two consecutive quarters of shrinking GDP will have been met.

"Looking forward, downside risks remain, and there is clearly no bar on further easing," said Ian Shepherdson, chief economist at High Frequency Economics Ltd.

Some observers have wondered if the Fed's policy moves are effective any more. After all, it would seem that nine rate cuts in a year would at least have had an impact on stock prices, which usually respond positively to lower rates. Instead, major stock indexes even before Sept. 11 were below the levels they held before the Fed started cutting rates.

The specter of a U.S. economy sinking despite short-term interest rates at or near zero which has happened to Japan in recent years has been raised by several observers. Most think the U.S. economic system is different enough from Japan's to avoid a similar situation, but the possibility that Fed policy alone won't help the economy is hard to ignore.

"A careful and flexible move on the fiscal side will really have more effect on bolstering confidence and resuming demand than monetary policy," Catherine Mann, senior fellow at the Institute for International Economics and a Fed staff member for 13 years, told CNNfn's Before Hours program.

On the "fiscal side," President Bush and Congress have approved a $40-billion emergency relief package and a $15-billion bailout of the airline industry in the days following the attacks. Bush and Congress are discussing further stimuli, which could include tax cuts and more government spending.

"The best way to stimulate demand is to give people some money so they can spend it," Bush said Tuesday morning.

Click here for's economic calendar

Giving people money possibly in the form of another advance payment on tax credit, like the tax "rebates" the government mailed this year would seem to be more effective at spurring immediate spending than interest-rate cuts, especially since many variable-rate credit cards are already at their rate "floors," long-term mortgage rates won't drop immediately, and many consumers have already accumulated considerable debt.

"The problem is, the private sector doesn't have the balance sheet capacity to take on more debt, and the banking system is not in a position to extend more credit," said former Fed economist Lacy Hunt, chief economist at Hoisington Investment Management. "So monetary policy may not work at all."

Still, the Fed has much more flexibility to act and react quickly to changing circumstances than the Congress and can raise rates again if necessary.

"Monetary policy is the perfect instrument for these circumstances," said Bill Cheney, chief economist at John Hancock Financial Services. "The Fed can keep pushing as needed, but still can turn on a dime and pull back as soon as spending starts to rebound."

Click here to find a mortgage rate

Most economists expect the combination of fiscal stimulus, together with the Fed's aggressive monetary policy and tax cuts passed earlier this year, will return the economy to growth next year, though it could shrink the rest of 2001.

It's also possible that the delayed impact of so many interest-rate cuts will hit all at once, forcing the Fed to raise rates again to cool the economy off and avoid inflation. Still, inflation has not been a problem for some time and is not likely to be one any time in the near future.

"There is absolutely no risk of inflation whatsoever," former Fed Governor Wayne Angell, chief economist with Bear Stearns, told CNNfn's Market Call program. "The Fed is powerless to inflate under these conditions."

The latest rate cut takes the fed funds rate below the 2.7 percent consumer price index, a standard measure of inflation. But rates are still well above the 1.3-percent personal consumption expenditures price index in the GDP report, which analysts say the Fed watches more closely. This means rates can still fall some distance before "real" or inflation-adjusted rates hit zero.

As usually occurs after Fed actions, M&T Bank (MTB: up $0.58 to $73.71, Research, Estimates), Bank of America (BAC: up $0.36 to $59.31, Research, Estimates) and FleetBoston Financial (FBF: up $0.53 to $36.92, Research, Estimates) immediately cut their prime lending rate to 5.5 percent from 6.0 percent, and other banks were likely to soon follow suit. graphic

-- from staff and wire reports


Special report: Eyes on the Fed

Bush, Congressional leaders look for economic stimulus - Oct. 2, 2001

U.S. manufacturing shrinks after attacks; consumer spending up, incomes flat in August - Oct. 1, 2001

2Q GDP revised higher - Sept. 28, 2001

U.S. consumer confidence falls - Sept. 25, 2001

Recession could follow terror attacks, but it might not last long - Sept. 20, 2001

Fed cuts rates a half percentage point - Sept. 17, 2001


Federal Reserve

Note: Pages will open in a new browser window
External sites are not endorsed by CNNmoney