FOMC Lowers Fed Funds Rate Half a Percentage Point

The Federal Open Market Committee voted today to cut the target federal funds rate from 5 1/4%, where it has remained since June 29, 2006, to 4 3/4%.  Cutting the rate by 50 basis points instead of a more modest cut of 25 basis points is a vigorous response to problems in the financial market triggered by the subprime mortgage meltdown. This is the first fed funds rate cut since June 25, 2003, when the FOMC lowered the target federal funds rate from 1 1/4% to 1%.

Federal Reserve Chairman Ben Bernanke, unlike his predecessor Alan Greenspan, had repeatedly expressed reluctance to use a federal funds rate cut as a boost to the U.S. economy which has been troubled by losses for subprime lenders and investors.  The U.S. housing market and financial markets have also been in a decline.  One problem with this rate cut is that its effects are likely to be short-lived and may be viewed as bailing out the lenders and markets that had a hand in creating the problem. In addition, the Fed is always concerned about the trade-off between keeping interest rates low enough to encourage economic growth but not so high that inflation can get out of hand.

In a related action, the Federal Reserve also lowered the discount rate 50 basis points to 5 1/4%.

The rate cuts were requested by the Federal Reserve Banks of Boston, New York, Cleveland, St. Louis, Minneapolis, Kansas City, and San Francisco.

The votes on both actions were unanimous.

The discount rate is the interest rate banks pay to borrow from the Federal Reserve.  The federal funds rate is the interest rate banks charge each other for overnight loans of balances they hold with the Federal Reserve Banks.

Link to FOMC announcement:  http://www.federalreserve.gov/newsevents/press/monetary/20070918a.htm

(ag) Sept. 18, 2007, in Economy/Interest Rates