Latest cut takes key rate as low as it goes

Fed promises to use other methods to get credit moving again

Under chairman Ben Bernanke the Fed lowered a key rate to nearly zero. (Reuters/ File)

The Federal Reserve, after slashing its key interest rate almost to zero, said yesterday it will now pursue unconventional actions that one economist called the "moral equivalent of printing money" to try to stop a quickening economic slide.

The Fed yesterday cut its federal funds rate, which banks charge each other for overnight loans, from 1 percent to a range between zero and 0.25 percent, the lowest on record. In an extraordinary statement, Fed policy makers acknowledged that the use of short-term rate cuts, its preferred tool for boosting the economy, is all but spent, and they will turn to other methods to pump cash and credit into the economy.

Those options include buying securities backed by mortgages and other consumer and business loans, which would free up money for banks to make more loans; and buying long-term Treasury bills, which would lower rates on mortgages and other long-term loans.

Many long-term rates are tied to Treasury bill interest rates, which move in the opposite direction of price. When prices rise, that means demand is strong, so the government doesn't have to pay as much in interest to attract buyers. In buying Treasuries, the Fed would increase demand for the securities, sending their rates and other long-term rates lower.

"It's the moral equivalent of printing money," said Nariman Behravesh, chief economist at IHS Global Insight in Lexington. "The economy is in free fall, and the Fed will do whatever is necessary."

The Fed's bold moves helped send stocks sharply higher. The Dow Jones industrial average rose 359.61 points to close at 8,924.14. The broader Standard & Poor's 500 index rose 44.61 to 913.18. The technology-heavy Nasdaq Composite index gained 81.55 to 1,589.89.

Despite Wall Street's reaction, the Fed's dramatic moves illustrate the dire condition of the economy, analysts said. US employers cut more than a half-million jobs in November, the Labor Department reported recently, and many economists say job losses could be even worse in December.

On Monday, the Fed reported that US factories cut production sharply last month, and yesterday there was more bad news. Housing starts plunged 19 percent in November, the sharpest drop in 24 years, while building permits, an indicator of future activity fell, to the their lowest level since 1960, the Commerce Department reported.

Meanwhile, the Labor Department reported that consumer prices, led by a collapse in energy prices, fell at the fastest rate on record. Falling prices would usually be considered good news, but now they represent another sign of a shrinking economy, analysts said. Consumers, whose spending accounts for about 70 percent of US economic activity, aren't buying so businesses are cutting prices.

"So here we are: rock bottom," said Ian Shepherdson, chief US economist at High Frequency Economics in Valhalla, N.Y., in a note to clients after the Fed announced the rate cut. "This is a terrible, chastening day."

Yesterday's rate cut follows a series of aggressive and often unprecedented actions by the Fed to stop the economy's downward spiral. The Fed has cut its benchmark rate, which influences most other lending rates, by 4 percentage points in the past year.

Normally, lower rates boost the economy by encouraging consumers and businesses to borrow and spend, but credit markets are malfunctioning. Banks, worried about getting paid back, are reluctant to lend, while businesses and consumers, worried about losing customers or jobs, are reluctant to borrow. The result: The impact of lower rates is diminished.

That's why the Fed has to take unconventional steps such as buying Treasury bills and mortgage-backed securities, said Gus Faucher, director of macroeconomics at Moody's Economy.com in West Chester, Pa.

"They're pulling out all the stops and trying new things," Faucher said. "The goal is to push cash into the system."

Economists said the Fed is going to need additional help from Congress and President-elect Barack Obama in the form of a spending package of at least $500 billion to further stimulate the economy. That package could include everything from funding for public works to tax cuts to extended unemployment benefits.

"The only light at the end of this tunnel is the Obama stimulus," said Behravesh, of IHS Global Insight. "But is has to be big, bold, and quick."

Robert Gavin can be reached at rgavin@globe.com.