Federal Reserve cuts rates to 1.25% [Half Point Cut, Not The Quarter Point Expected]

WASHINGTON (CBS.MW) - The Federal Reserve cut interest rates Wednesday to try to get the economy humming again.

By cutting the federal funds target rate to 1.25 percent, the Fed hopes to boost consumer and investor confidence and pump more money into an anemic economy.

"Greater uncertainty, in part attributable to heightened geo-political risks, is inhibiting spending, production and employment the Fed said.

It was the first rate cut since December. The Federal Open Market Committee had cut rates 11 times in 2001, bringing the fed funds rate from 6.50 percent to 1.75 percent.

The move was expected on Wall Street. Forecasters were nearly unanimous in their belief that the FOMC would ease monetary policy Wednesday.

Financial markets had fully priced in a 25 basis point cut and were hedging their bets that the cut would be an aggressive 50 basis point cut.

The federal funds rate is the interest rate banks charge each other for overnight loans. The Fed targets this rate by buying or selling Treasurys in the open market. To goose the economy, the Fed adds money to the system. To contract the economy, the Fed takes money out. Read more about monetary policy.

The economy officially entered a recession in March 2001 after months of slipping industrial production and falling stock prices.

The FOMC had held its fire since last December. It is likely that the private-sector National Bureau of Economic Research will eventually determine that the recession ended in December or January -- if the economy doesn't dip back into a recession now.

The NBER said Tuesday that the recession "may have come to an end," but would wait to make its decision.

The FOMC has been warning since August that the main risk to the economy is a relapse, signaling its intention to cut rates again if the economy appears to be worsening. Even before the FOMC changed its official risk assessment, the committee had said the most likely outcome was a tepid recovery, with uncertain growth in consumer spending and capital investment remaining weak for months.

At the Sept. 24 meeting, two of the 12 FOMC members -- Gov. Edward Gramlich and Dallas Fed President Robert McTeer -- voted in favor of an immediate rate cut. It was the first time a Fed governor had dissented in seven years.

The Fed's 11 rate cuts pushed down market interest rates. Automakers offered zero-percent financing on many new cars, which drove sales to record levels. Mortgage rates, too, fell to historic lows, keeping the residential construction and real-estate markets booming.

Throughout the recession, consumers maintained a steady pace of spending, an unusual occurrence in a most unusual business cycle. Consumers' incomes never faltered, due to a timely tax rebate and tax cut and to a relatively low unemployment rate even in the depths of the recession.

But now the evidence shows that consumers have become inured to low rates. Auto sales have fallen back. Retail sales have slowed. Consumer confidence has fallen to nine-year lows, as the bear market and war talk take their toll on consumer psyches.

Some worry that rate cuts wouldn't spur consumer demand because consumers are heavily indebted at the same time they are trying to save more to make up for the pathetic performance of their stock portfolios.

Consumer spending has propped up the economy, which has grown 3 percent in the past year. Growth is uneven, however. In the third quarter, spending on cars accounted for more than half of the 3.1 percent growth rate.

The low interest rates never really benefited businesses. The spread between Treasury yields and corporate bond yields widened, as creditors began asking tough questions about inflated balance sheets.

Companies didn't face a full-fledged credit crunch; neither was there much demand for credit to expand businesses. Companies had to work off their inventories first. Without a pickup in demand, companies had no incentive to invest in new buildings or equipment or to hire workers.

Well my comment to this is what does it mean for the common middle class american? Nothing. Why? Because with all that has happened with the economy and with so many falling behind in bills and hanging on by the skin of their teeth, these low interest rates only apply to those with perfect credit reports. If you have strikes against you then you pay a high interest rate. Our credit was perfect till up to about 1 1/2 years ago now no one will give low interest rates as they look at our slow pay status. Its a no win situation. Went for a low interest loan on our farm....lol that was a joke. We were told altho we bought 31 acres and built considering all of it now they will only look at our home and 5 acres the rest of the land is worth nothing to them. The working class never wins just everyone else.

"For instance, drop the price on a house or a car low enough and you WILL sell it this month, even if it's been sitting around at a higher price for months or years." - Southack

"Whether that's a good thing or a bad thing depends on the nominal price at which I bought the house..." - Tauzero

No, it doesn't depend upon the price paid to determine whether it is better for both parties.

The new lower price may benefit BOTH the buyer and seller. The buyer gets the goods for fewer Dollars, while the seller eliminates further downside risk and increases her current liquidity. Her alternative, after all, is not making the sale at all and being stuck with the non-income-producing asset (read: liability).

Likewise, the unemployed person who accepts a job at a "lower" wage than she desired is better off than if she remained unemployed.

I am afraid you are confused friend, there is no way that deflation makes us ALL richer anymore than inflation makes us ALL richer. Some benefit but others are hurt. Those who have fixed incomes will benefit greatly from deflationary price reductions provided their incomes stay fixed but those who own assets will see the value of those assets decline. Those who own assets which are heavily mortgaged will be hit doubly hard as the assets decline in value while it becomes much harder to raise the money to pay off the debt as the value of each dollar rises and the debt remains fixed. A house mortgaged for two hundred thousand can drop in value to a hundred thousand leaving the homeowner no choice but to walk away and lose his investment and his credit rating, meanwhile renters may see their rent drop. I fail to see how the speed of money moving can prevent all this.

"Deflation is devasting to debtors and the Feds are the biggest debtors in the room. This is why they like to debase the currency whenever possible. That game may well be ending."

Nonsense. The Feds can eliminate deflation simply by turning up the speed on government money-printing presses (Hiedelberg, one presumes). This increases the supply of currency, reducing its per unit value, and completely eliminates deflation.

But most people like deflation. That's why people shop at "sales". That's why they go to yardsales, buy used cars, et al. Why? Because they want their Dollars to buy more (everything). That's what deflation does, it lets you buy more things with your Dollars.

2 times out of 3, deflation will be a good thing in sum. That "third" danger, however, is that the speed of money could slow down due to fears associated with such an environment. If the speed of money slows down, then deflation benefits only the fabulously wealthy at the expense of everyone else. If the speed of money remains constant or increases, then deflation multiplies the wealth effect for everyone except the most indebted (read: Japan, Sweden).

What you've got, however, is a bad case of fear. All of your posts revolve around the end of the world, ubiquitious gun-type nukes, massive biological warfare against civilians, massive real-estate collapses, and other Chicken Little scenarios.

That sort of fear is NOT the epitome of the average American. Most of us don't spend our waking moments preaching about "iminent" social/political/economic collapses.

"But surely deflation (or, to be more accurate, an expectation of deflation) inevitably causes a slowdown in the speed of money?"

As surely as the expectation of inflation causes an increase in the speed of money, or else I am totally confused. In an inflationary environment smart people want to get money off their hands and into physical assets before the value of the money drops but in a deflationary environment smart people want to get physical assets off their hands and turn them into cash before the price of their assets drop. This is what happened during the great depression or so I have been told by people who lived through it. The money didn't disappear but it was all concentrated into a very few hands and it can happen again. In fact all evidence indicates that it is happening again.

" I fail to see how the speed of money moving can prevent all this."

Then you would likewise fail to see how computer makers could benefit from moving more compauters at lower prices, how cellular phone companies benefit from people making more cell calls at lower rates, or how a long distance company might benefit from larger call volumes at reduced prices.

How does Intel manage to keep cutting the prices on CPU's?! Those crazy guys must not understand business like you do...

"As surely as the expectation of inflation causes an increase in the speed of money, or else I am totally confused."

Inflation CAN cause an increase in the speed of money, but inflation can also kill the speed of money altogether if it is extreme enough to cause people to eschew a currency and move towards a barter economy (see: South America).

The Feds can eliminate deflation simply by turning up the speed on government money-printing presses

How exactly do the feds change the velocity of M1,M2,M3.

2 times out of 3, deflation will be a good thing in sum. T

hat "third" danger, however, is that the speed of money could slow down due to fears associated with such an environment.

deflation due to productivity increases is ok.

deflation can also occur due to malinvestment and the collapse of speculative bubbles...if this happens in a high debt environment it can be rather ugly.

Oh, those things will probably happen. No need to get all worked up over them.

I'm so thrilled at the Republican's gains today, I've shocked myself. As I said before, abolish the 16th and IRS and I'll join the John Birchers (actually it would be a matter of rejoining since they recruited me when I was 13).

Actually people tend to buy during inflationary times to avoid higher prices later on. In severe inflation they will buy anything and everything up to the limit of their income because their money is dropping in value on a daily basis. On the other hand, during deflationary times a smart buyer will put off purchases as long as possible to get a lower price. This is what happens in the real world, I am not interested in someone's pet theory.

"I'm so thrilled at the Republican's gains today, I've shocked myself. As I said before, abolish the 16th and IRS and I'll join the John Birchers (actually it would be a matter of rejoining since they recruited me when I was 13)."

Hmph. I took you for more of a wild-eyed "libertarian-i-want-my-drugs-and-no-taxes-and-kill-every-possible-government-service" sort of revolutionary.

Yes, I too am pleased with the Republican gains, but not surprised. The Dems have been at war with rural America, the Dems have missed the demographic trend of Baby Boomers beginning to become first-time grandparents (the most conservative time of life), and the Dems had no new ideas at all with which to combat Bush's tax cuts, homeland security, smash the axis of evil, appoint Conservative judges, faith-based charity, et al.

Perhaps we'll finally see an elimination of the double-taxation on dividends as well as the permanent end to the Death Tax. That sort of thing won't be bottled up by Daschle in some private "committee" any longer, at the very least.

Egads. I hope this doesn't mean that you and I share any common ground. That would rain on my parade. You're much too useful to hold up as a counter-example to far too many of the points that I wanted to make...

The other thing to remember is that "inflation" simply means that things cost more.

Money is a unit of measure, an agreement between people.

Anytime this unit of measure is distorted by either inflation or deflation, someone gets hosed. (yes, I know prices can decline due to productivity increases...some folks like applied materials have figured out how to profit in such environments ...which is why I'm heavily long amat). ....getting hosed causes people to engage in fewer collaborative activities from fear of getting hosed again...this is the source of the "fear" which you claim effects velocity.

They are losing control of the money supply as we speak and you are trying to obscure the matter with velocity hand waving....Contrary to your previous assertions the Feds don't have control over velocity nor is it the primary source of inflation/deflation.

Your cheery optimism (appreciated when backed with sound arguments) seems to be eclipsing your good sense this evening. Try laying off the words: nonesense,chicken little,doom and gloom for a month and try actually debating the issues.

"Actually people tend to buy during inflationary times to avoid higher prices later on. In severe inflation they will buy anything and everything up to the limit of their income because their money is dropping in value on a daily basis."

So naturally Americans spent their entire paychecks buying gasoline during the Arab oil embargo.

Oh, they didn't. I see. Oh well, time for a new theory for you...

"They are losing control of the money supply as we speak and you are trying to obscure the matter with velocity hand waving....Contrary to your previous assertions the Feds don't have control over velocity nor is it the primary source of inflation/deflation."

Let's be clear: If I said that the Fed had control over the velocity of money, then I misspoke (I doubt that I said it in the first place, however).

What I should have said (and most probably did say) was that the Fed has control over inflation. If the Fed wants to end deflation, all that it has to do is turn up the speed on their printing presses and flood the market with money. But having control over inflation does NOT equate to having control over the speed of money.

The speed of money tends to be determined by the competing forces of fear and greed, mitigated by transaction costs and physical/technical hurdles/inefficiencies. This can usually be detected by observing whether the population is saving/hoarding or borrowing/spending in various increments.

Hmph. I took you for more of a wild-eyed "libertarian-i-want-my-drugs-and-no-taxes-and-kill-every-possible-government-service" sort of revolutionary.

I don't use drugs. I have been warrantlessly searched one too many times..

Of course, we should kill every *possible* government service..Some of them are bound to be essential.

Yes, I too am pleased with the Republican gains, but not surprised.

Nor am I. The Democrats are hopeless. They have nothing to offer. I was so confident of an R Senate victory I even managed to get some protest votes in without worrying too much.

Now, I will be astounded if they implement real reforms...In fact, not just astounded,converted.

Ayup. Serious tax reform now. Div's are hard to fake. Then Social Security.

Well, if you insist on having a foil: The GSE's are going down hard you pink, bull headed dolt.

There you go again, no you don't buy up gasoline during an oil embargo because most people don't have storage facilities and gasoline is perishable, by the way. What you do during inflation is buy real estate, gold or whatever else you think will hold its value. I know what I am talking about and if you don't understand me, you will if you live long enough. Rising prices or falling prices don't affect the amount of real wealth in the world, they only transfer wealth from some people to other people depending on how they choose to react to changing prices.

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