With the country spiraling deeper into recession, the Federal
Reserve is ready to slash its key interest rate -- perhaps to an
all-time low-- in hopes of cushioning some of the economic fallout felt
by many struggling Americans.
To battle the worst financial
crisis since the 1930s, Fed Chairman Ben Bernanke and his colleagues
already have ratcheted down their main lever for influencing the
economy -- the federal funds rate -- to 1 percent, a level seen only
once before in the last half-century.
The Fed opens a
two-day meeting Monday to assess to economy and decide its next move on
rates. Another reduction to the funds rate, the interest banks charge
each other on overnight loans, is all but certain to be announced
Tuesday.
Many economists predict the Fed will cut its
rate in half -- to just 0.50 percent. A few think the Fed could opt for
an even more forceful action -- lowering rates by a whopping
three-quarters percentage point or more. If that larger cut occurs, it
would be the lowest on records that track the monthly average of the
targeted funds rate going back to 1954.
Even an aggressive rate reduction won't turn the economy around, analysts said.
"It
is not so much going to give the economy a big push forward. It's more
a case of trying to help the economy from being pushed further backward
by all these negative events," said Stuart Hoffman, chief economist at
PNC Financial Services Group.
However deeply the Fed
decides to cut rates, the prime rate -- now at 4 percent -- for many
consumer and small-business loans would drop by a corresponding amount.
The prime lending rate is used to peg rates on home equity loans,
certain credit cards and other consumer loans. Cheaper rates could give
pinched borrowers a dose of relief.
The goal of lower
borrowing costs is to entice people and businesses to spend more, which
would revive the flat-lined economy. So far, though, the Fed's
aggressive rate reductions have failed to lift the country out of a
recession that started last December.
Clobbered by the
financial crisis, worried banks have hoarded their cash and been
extremely reluctant to lend money to customers. Fearful consumers,
watching jobs vanish and their investments tank, have sharply cut back
their spending, including big-ticket purchases like homes and cars that
typically involve financing.
The negative forces have fed
off each other, creating a vicious cycle that Bernanke and Treasury
Secretary Henry Paulson have been desperately trying to break.
To
unlock lending and get financial markets to operate more normally, the
U.S. has resorted to a string of radical actions, including a $700
billion financial bailout where the government is making cash
injections in banks in return for partial ownership stakes.
In terms of rate cuts, the Fed is getting ever closer to running out of ammunition.
It
can lower the funds rate only so far -- to zero. Even if that were to
happen -- a point of debate among economists -- the prime rate would
fall to 3 percent but no lower.
Against that backdrop, Bernanke says the central bank is exploring other ways to stimulate the economy.
The
Fed could buy longer-term Treasury or agency securities on the open
market in substantial quantities, Bernanke says. This might lower rates
on these securities and help spur buying appetites.
Another
option the Fed has mulled: issuing its own debt, which would give the
central bank cash and more flexibility to battle the financial crisis.
To do that, however, the Fed would need new powers from Congress.
"The
Fed wants to show that it has tools and options and is not out of
tricks because interest rates are very low," said Michael Feroli,
economist at JPMorgan Economics. "The problems holding back the economy
are fairly long lived in nature."
To combat the financial
crisis, the Fed already has created first-of-its-kind programs, such as
getting cash directly to companies by buying up mounds of "commercial
paper," the short-term debt firms use to pay everyday expenses such as
payroll and supplies.
It also recently launched massive
programs to boost the availability of consumer credit, including that
for cars, student loans, homes and credit cards. The Fed also is making
loans to banks, is providing a financial backstop to the mutual fund
industry, and has injected billions of dollars in financial markets
here and abroad.
The Fed could opt to expand programs by
enlarging loans it's now making, providing loans to other types of
companies, or buying more and different types of debt. The Fed's
balance sheet has ballooned to $2.2 trillion, from close to $900
billion in September, reflecting some of those other activities to get
credit flowing again.
Even with all the bold moves, the economy continues to sink deeper into despair.
Skittish employers axed 533,000 jobs in November alone. That drove the unemployment rate up to 6.7 percent, a 15-year high.
Since
the start of the recession, the economy has shed nearly 2 million jobs.
Analysts predict another 3 million more will be lost between now and
the spring of 2010.
Last week alone, Bank of America Corp.,
tool maker Stanley Works and Sara Lee Corp., known for food brands such
as Jimmy Dean and Hillshire Farm, announced job cuts.
General
Motors Corp., Chrysler LLC and Ford Motor Co., meanwhile, are fighting
for their survival. GM and Chrysler have said they're in danger of
running out of money within weeks. The White House is exploring new
ways to help Detroit after rescue efforts collapsed in Congress.
With
the employment market eroding and consumers retrenching, the economy
could stagger backward at a shocking 6 percent rate in the current
October-December quarter, analysts predict. It shrank at a 0.5 percent
pace in the third quarter.
President-elect Barack Obama is
advocating an economic recovery plan that includes spending on big
public works projects to bolster jobs. His plan also includes tax cuts
to spur consumers to spend more and businesses to step up investment
and hiring.
Americans are sorely feeling the toll of the housing, credit and financial crises.
Households'
net worth fell 4.7 percent in the third quarter to $56.5 trillion as
people watched the value of their homes and investments tank. It marked
the fourth straight quarterly decline, the Fed said.
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