Fed cuts key interest rate; Wall Street rejoices

Published 12:00 am Wednesday, January 3, 2001

AP and staff reports

WASHINGTON – The Federal Reserve, faced with a rapidly slowing economy, unexpectedly cut a key interest rate Wednesday by one-half point in an effort to avert a serious downturn. It was the first decrease in rates in two years.

Wall Street reacted instantaneously. The Dow Jones industrial average jumped out of negative territory to rise by almost 380 points before closing the day up 299.60 points at 10,945.75. The technology-heavy Nasdaq index, which lost close to 7 percent of its value on Tuesday alone, jumped 324.83 points, or 14.2 percent, to close at 2,616.69, its biggest one-day gain ever.

Email newsletter signup

The Fed cut its target for the federal funds rate – the interest banks charge each other on overnight loans – to 6 percent from 6.5 percent, a nine-year high.

It also cut its mostly symbolic discount rate by a quarter point to 5.75 percent. The Fed said it stands ready to cut the discount rate by another quarter point to 5.50 percent on the request of Federal Reserve banks.

”These actions were taken in light of further weakening of sales and production and in the context of lower consumer confidence, tight conditions in some segments of financial markets and high energy prices sapping household and business purchasing power,” the Fed said in a statement.

The rate cut was unusual, occurring between meetings of the central bank’s interest-rate committee. The last time the Fed changed rates between meetings was a quarter-point cut in October 1998, when the central bank was moving aggressively to counter worldwide financial turmoil caused by the Asian currency crisis.

The last time the central bank reduced the federal funds rate by as much as a half percentage point was July 1992.

The average consumer won’t likely feel a direct effect of the rate cut, said Britton & Koontz First National Bank CEO Page Ogden. But that doesn’t mean the action won’t impact the public’s &uot;overall sense of economic well-being,&uot; he said.

The perception of the economy is the one of the biggest things the Federal Reserve must try to turn in order to improve it, he said. &uot;If people lose confidence in the economy, they don’t spend as much,&uot; he said. &uot;People lose jobs because production goes down. It all has to do with perception and confidence.&uot;

While the announcement caused a flurry of activity on Wall Street, William McDonough, a financial adviser with Edward Jones in Vidalia, La., said he will advise clients to stick with their investments – even if the economy goes into recession.

Trying to predict the market, he said, is &uot;market timing, and timing the market never works. A recession is not a disaster.&uot;

Still, Ogden does not think the nation’s economy is necessarily headed in that direction.

The definition of recession, he said, is negative growth for two quarters. He recalled periods with similar economic conditions over the past 25 years – namely, times of higher gas prices – that were much harder on consumers.

&uot;I don’t think we’re looking at those kinds of problems because the economy is better managed now,&uot; Ogden said.

Another way to recharge the economy, Ogden said, is to cut taxes, a move President-elect Bush has been pushing since the campaign. While there is no guarantee taxpayers will spend that money, the thinking is that a tax cut will inject more money into the economy.

The Federal Open Market Committee, which includes Fed Chairman Alan Greenspan, Fed governors and five of the 12 presidents of Federal Reserve banks, is scheduled to meet Jan. 30-31 to review interest rates.

Hosting an economic meeting in Austin, Texas, President-elect Bush praised Greenspan for ”a bold move.”

”I think the cut was needed,” Bush said during a picture-taking break. ”It was a strong statement that measures must be taken to make sure that our economy doesn’t go into a tailspin.”

Bush said ”one of the messages that Mr. Greenspan sent is that we need bold action, not only at the Fed, but I would interpret that to mean bold action in the halls of Congress, to make sure this economy stays vibrant.”

”I intend to take another bold step by asking Congress to enact tax reform and tax relief,” he said.

Economists said the Fed’s actions not only reflected concern about the weakening economy but were intended to send a message to Bush.

”Greenspan and Co. are protecting their turf and are sending a signal to Bush: ‘We’re the sheriff in town as long as we have the monetary reins over the economy we’re going to dictate what happens,”’ said Richard Yamarone, economist with Argus Research Corp. in New York.

Bush has said Congress should pass his massive tax cut ”as an insurance policy” against a potential economic downturn. Bush has made the $1.3 trillion reduction in taxes over 10 years the centerpiece of his economic program.

It was less than a month ago, at its last meeting of 2000, that the central bank switched its chief policy concern from inflation fighting to recession risks. After that announcement, stocks on Wall Street slumped, reflecting disappointment by investors that the Fed had not cut rates.

In the part of Wednesday’s statement that reflects possible future action, the central bank maintained its December position that the biggest threat to the economy is recession, not inflation.

”The risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future,” the Fed said.

The Fed added that inflation pressures ”remain contained” and that to date there is ”little evidence to suggest that longer-term advances in technology and associated gains in productivity are abating.”

In response to the cut in the federal funds rate, Southwest Bank of St. Louis said it would cut its prime rate. Other commercial banks also were expected to announce half-point reductions to their prime lending rate from the current nine-year high of 9.5 percent to 9 percent. The prime rate is the key benchmark for million of loans, from home equity and unpaid credit card balances to short-term loans for small businesses.

The economy slowed dramatically in the third quarter of 2000, growing at an annual rate of 2.2 percent, the weakest pace in four years. That compared with a sizzling 5.6 percent rate in the second quarter.

More recently, consumer confidence has fallen sharply, the stock market has been volatile, the manufacturing sector is slowing and retail sales have been lackluster.


On the Net:

The Federal Reserve: http://www.federalreserve.gov