Fed drops rate to record low

Bob Moon Dec 16, 2008

Fed drops rate to record low

Bob Moon Dec 16, 2008


TESS VIGELAND: Today the Fed lowered the benchmark federal funds rate to a mere quarter of a percentage point. Lowest it’s ever been. Ever. It’s an effort to stem all kind of problems from a worsening recession to a big drop in retail prices.

Marketplace’s Bob Moon is here with us, and Bob this is quite the bold move.

BOB MOON: Indeed, the Fed cut more than many on Wall Street were expecting. Deeper by a quarter percent. And the financial markets reacted in various ways. The stock market surged. But the Fed pulled the rug out from under some investors who had been figuring on a smaller rate cut, so some people rushed to buy up Treasury notes in anticipation that the Fed will keep pushing rates lower and that had the effect of driving yields on T-bills to historical lows.

VIGELAND: OK, well, how much lower can interest rates really go?

MOON: Well, you can’t get much lower than a quarter percent. So the Fed at this point has to start turning toward some unconvential tactics to drive interest rates even lower. We heard from the Fed today this vow to use all available tools to deal with this stubborn crisis. Well, that could mean the Fed could start buying up Treasury notes. And that would push T-note prices up, effectively pusing interest rates even lower by forcing those yields on government bonds lower. The value of the dollar, by the way, also took a hit today in anticipation that it might not offer as high a return.

VIGELAND: Why is the Fed feeling like it has to take such drastic action?

MOON: Well, the Fed sent a strong message today that it intends to keep these interest rates extremely low. And there’s one line of thought, Tess, that the banks have kept a lot of their money on deposit in the Federal Reserve’s vaults because they could actually earn a little more doing that than lending the money to each other. So now, if the banks can’t get as much by letting that money sit, they might be prodded into lending again — to businesses, to us — if only to get a better return by having to invest it out there in the Marketplace.

VIGELAND: Well, let me ask you about another figure out today, the Consumer Price Index. This is what we pay at the checkout counter. And, prices actually going down right now. So, this part of the Fed action as well?

MOON: Yeah, we actually saw prices tumbling by the most that they have since the days of the Great Depression. I talked today to Mike Shank. He’s the chief economist at the Credit Union National Association. And he is one of a growing number of economists who are really starting to worry about the opposite of inflation now — deflation. And he says that can feed on itself.

MIKE SHANK: Once the general level of prices starts to go down, and it becomes obvious that there’s general weakness in prices, people tend to put off their purchases because prices will be lower in the future.

VIGELAND: But, if you look closely at these numbers, we’re really talking about food and energy prices that have gone down so drastically. And those are volatile. You get to the core consumer number, it was actually steady, right?

MOON: That’s true but it’s all relative, Tess. Shank told us he’s still worried that this trend represents a pull-back in recent months.

SHANK: The Fed’s job is not to look at the last year. It’s to sort of think about what might happen 12 months from now. And how they might circumvent some of the nastiness that appears to be on the horizon.

MOON: Which explains why the Fed took this bold step today. And that gives some experts hope that we can head off a declining price spiral. Here’s what economist John Lonsky told us at Moody’s Investor Service:

JOHN LONSKY: I’m skeptical about the threat of deflation, mostly because the Federal Reserve and federal government are currently doing whatever is necessary to reinvigorate a now-sinking U.S. economy. And, as a result, price-deflation fears will disappear quite rapidly.

MOON: In other words, Tess, cut the rates and cross your fingers.

VIGELAND: Got ’em crossed. Marketplace’s Bob Moon, senior business correspondent, thanks so much.

MOON: Thanks, Tess.

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