The
US Federal Reserve chairman Ben Bernanke and his central bank colleagues slashed
key interest rates by half a per cent (50 basis points) on Tuesday 18 September.
The first cut since 2003, it is a radical move that seeks to prevent a major housing
slump and a crippling credit crunch from driving the world''s largest economy into
a recession. The
Fed funds rate, which had been held at 5.25 per cent since June 2006, was lowered
to 4.75 per cent. The funds rate is the interest that banks charge each other.
At the same time, the Fed cut its discount rate for direct loans to banks by a
half per cent, to 5.25 per cent. Wells
Fargo, Bank of America, and many other commercial banks quickly announced that
they were slashing their prime-lending rate by a half-point, to 7.75 per cent.
The cut is likely to lead to a lowering of borrowing costs across the economy,
for consumers and businesses alike. The
reverberations were immediately felt on Wall Street, which celebrated by driving
up the key Dow Jones index by 336 points, the biggest one-day jump in nearly five
years. Economic
and political pressure has been building up on the Fed to act. Politicians, shaken
by record-high home foreclosures, welcomed the move. The action is intended to
help forestall some of the adverse effects of a slumping housing real estate and
housing market on the broader economy. Official
figures showed that US producer prices fell 1.4 per cent in August, far more than
had been expected. This was the steepest fall since October, and followed a higher-than-normal
0.6 per cent increase in July, the US Labour Department said. Analysts say that
overall weakness in the US economy has made it harder for manufacturers to raise
prices. Whether
Bernanke can handle the crisis successfully is the biggest challenge he has faced
so far in the 19 months he has been at the helm of the Fed. "Today''s action
is intended to help forestall some adverse effects on the economy that might otherwise
arise from disruptions in financial markets and to promote moderate growth over
time," the Fed said in a statement released after its closed-door meeting. The
Fed''s action means rates will drop on a variety of loans. It will become less
expensive for people to finance credit card debt and for homeowners to take out
popular home equity lines of credit, which are used to pay for education, home
improvements or medical bills. It
will also help some homeowners whose adjustable rate mortgages reset in the fall.
But, say experts, the rate reduction could take three to nine months to ripple
through the economy and bolster overall activity. Notwithstanding
that, they say, the aggressive action has underscored the Fed''s resolve. Analysts
predict the Fed will lower rates again, probably by a more modest quarter per
cent, at its next meeting in October. Yet another rate reduction could come in
December, the last meeting of this year, if the economy is seen to falter. The
Fed itself has left the door open to another rate move: It said it will "act
as needed to foster price stability and sustainable economic growth". The
Fed''s own economic assessment of the present situation is sombre: "The tightening
of credit conditions has the potential to intensify the housing correction and
to restrain economic growth more generally," it said. What
that means is that the troubled housing market and credit problems could short-circuit
the six-year-old economic expansion that the US has enjoyed. Financial turmoil
has sharply intensified since the Fed''s last scheduled meeting in early August. If
ordinary people and businesses cut back on spending and investment, it could throw
the economy into a tailspin. Tuesday''s rate cut aims to make sure that doesn''t
happen. But the economy is not quite on track as yet, and the situation for the
Fed could become tricky. In
a media interview on Monday 17 September, former Fed chairman Alan Greenspan said
the odds of a recession are growing. He said the odds had moved up to more than
one-third, but wasn''t near 50:50 as yet. Earlier this year, his prediction of
a one-in-three chance of a recession had caused Wall Street to nosedive. Analysts
expect the economy to slow down. The expected growth rate, of about 2 per cent
in the ongoing July-to-September quarter, would be just half the growth rate of
the previous three months. Widely expected fears have been that growth in the
final three months of this year could turn out even weaker. A
free flow of credit is vital for the smooth functioning of the national economy.
If credit becomes too difficult to get, it can damage peoples'' ability to buy
assets and goods like homes, cars and appliances. This, in turn, can crimp the
capital investment plans and employment numbers of businesses. US
employers cut 4,000 jobs in August. This is the first time the economy has lost
jobs in four years. The unemployment rate, now at 4.6 per cent, is expected to
move closer to 5 per cent by the year''s end. The
US is suffering its worst housing slump in 16 years. Higher interest rates have
squeezed homeowners; especially ''sub prime'' borrowers with low incomes and limited
ability to repay loans. Late
payments have shot up, and there have been record numbers of foreclosures. A number
of housing lenders have been forced out of business. Hedge funds and other investors
in subprime-related mortgage securities have got clobbered. The unsettling issue
is that the credit crisis has spread beyond the subprime market, badly affecting
more creditworthy borrowers. Bernanke
and his colleagues were accused of being out of touch with reality when they held
the key interest rate steady at 5.25 per cent in the Fed''s last meeting on 7 August.
Just days later, the Fed was forced to pump in billions of dollars into the US
financial system, to get distressed institutions out of the sub prime pit. Then,
on 17 August, the Fed took even more aggressive action and cut its lending rate
for banks. That the Fed has lowered that lending rate again on Tuesday shows that
the woes of the US economy are far from over. See: Sensex
breaches 16000-barrier
also see : General
reports on Banks & Financial Institutions
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