Fed Gives Faltering Economy A Nudge Central Bank Lowers Interest Rates To Help Prevent A Recession

The Federal Reserve cut interest rates for the second time in two months Wednesday, hurrying to the rescue of a faltering economy. Major banks immediately reduced their own lending rates, meaning lower borrowing costs for millions of Americans.

Private analysts said further rate reductions were likely as the Federal Reserve tries to stave off recession.

The Fed said it was cutting its target for the federal funds rate, the interest that banks charge each other on overnight loans, from 5.5 percent to 5.25 percent. It also reduced its largely symbolic discount rate, the interest it charges on direct loans to banks, to 5 percent.

The actions should stimulate economic activity by lowering the cost of credit. But the Fed’s statement said merely that the reductions could be made because “moderating economic expansion in recent months has reduced potential inflationary pressures.”

Chase Manhattan was the first major bank to announce a cut in its prime rate, and other banks quickly followed suit. The prime rate, the benchmark for many business and consumer loans, was cut to 8.25 percent from 8.5 percent.

Private economists, who had been urging the central bank to act, said they believed Wednesday’s reduction in the funds rate, the third since July, would not be the last.

“Given how soft the economy is, we are going to see more easing,” said Lawrence Chimerine, chief economist at the Economic Strategy Institute in Washington. “The Fed overtightened a year ago and they have been moving too slowly to reverse that. We have a threat of a recession.”

The central bank from February 1994 to February 1995 was increasing interest rates, doubling the funds rate from 3 percent to 6 percent in an effort to slow the economy enough to keep inflation in check.

The economy did slow. But when the Fed’s hoped-for “soft landing” threatened to turn into something worse, the central bank reversed course and trimmed the funds rate by a quarter point last July. While many economists expected a series of rate cuts, the central bank waited until December to trim again.

The Clinton administration, which is hoping for a strong economy in this election year, was cautious in its reaction. Treasury Secretary Robert Rubin and Joseph Stiglitz, the president’s chief economist, sought to emphasize the economy’s strengths at present rather than any recession threat.

“Although growth rates always vary from quarter to quarter … we believe the economy will remain healthy in 1996,” the two officials said in a statement.

But many analysts said the central bank will be forced to play catch-up now. They said Fed decision-making, which is never easy when the economy is at a turning point, was complicated this time by the lack of economic data due to the government shutdown.

“I think the Fed will keep us out of a recession. But it is going to be dicey,” said Martin Regalia, chief economist at the U.S. Chamber of Commerce. “The retail sales and consumer confidence numbers suggest a broad-based weakness in the economy.”

Many economists believe the overall economy, as measured by the gross domestic product, has down-shifted to an anemic growth rate of about 1 percent, a marked drop from the 3.2 percent rate last summer. A rate that slow means that an unforeseen shock could push the country over the edge into recession.

The last recession in 1990 occurred as the central bank was trying to reverse the effects of earlier credit tightening. Many analysts have thought that that downturn would have been avoided had oil prices not soared following Iraq’s invasion of Kuwait.

But transcripts of Fed meetings for the period released last week showed that Federal Reserve Chairman Alan Greenspan and other policy-makers failed to see mounting evidence of a downturn, insisting that the period of sluggish growth would soon be over.

“That mistake will not be repeated this time,” said Allen Sinai, chief economist at Lehman Brothers Global Economics. “The Fed has a lot of room to ease because inflation is not an issue.”