Thursday, May 1, 2008

Fed Makes Last Interest Rate Cut in Series to Stimulate Economy

by Amy Lillard

After seven months of interest rate cuts in a campaign to boost the sagging U.S. economy, the Federal Reserve cut a key interest rate yesterday and signaled this would be the last.

The Fed lowered the federal funds rate, the interest rate banks use when lending to each other, to 2 percent. The goal with this cut is to create lower borrowing costs for adjustable-rate mortgages, credit cards, or business loans, and to offer one more means to prevent the current economic downturn from extending.

In a statement issued with the cut, the Fed indicated this was potentially the last cut in the foreseeable future, but left open the possibility of further cuts if the economy continues to deteriorate. The cut comes at the same time that a new report indicated the economy grew at a small, but better than expected rate in the first quarter. The 0.6 percent annual rate growth, along with fiscal stimulus checks mailing this month, is influencing the Fed's restraint for the time being.

The risks from continued and prolonged interest rate cuts are significant, and important to weigh against the burgeoning economic problems. High inflation, caused by higher prices for food and energy, could raise expectations for future inflation, creating a self-fulfilling prophecy. Continuing to cut the interest rate could weaken the dollar further, and worsen inflation. Plus, continued lowering of rates could undermine the Fed's credibility as an authoritative source for fighting inflation and economic troubles.

Details about the higher prices for food and energy surfaced Thursday. The Commerce Department reported that consumer spending is up 0.4 percent, higher than forecasts. But inflation is responsible for much of this increased spending: without inflation, spending increased by 0.1 percent. The figure for consumer spending is important, as two-thirds of economic activity comes from consumers. Too big of a slowdown could push the country into a recession.

The interest rate cut is another bulwark against deepening economic worries, including the 1.1 percent drop in construction spending in March, a decrease lasting 23 straight months. Unemployment claims rose by 35,000 to 380,000 last week, almost double what economists expected. Unemployment and job losses are also expected to rise in April figures.

Washington Post Articles:

Fed Cuts and Signals Halt

Soaring prices for food, gas push consumer spending higher

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