Aggressive Fed Cuts Key Rate by a Half-Point

Bowing to growing concerns about a deep recession and the remarkable declines on Wall Street, the Federal Reserve lowered its benchmark interest rate by half a percentage point on Wednesday, tapping its most visible policy tool to free up more money for banks and businesses.

The move brings the Federal funds rate to 1 percent. While Fed policy makers now have less room to maneuver on interest rates if the economy deteriorates further, investors had been hoping for the relatively aggressive cut as a sign of vigilance among American central bankers seeking to restore the free flow of credit. The move brought the rate down to near the lows reached in 2003 and 2004.

But the economic outlook is much grimmer than it was in 2003. Back then, policy makers were trying to vanquish the last remnants of a downturn.

This time, policy makers face an economy that is sputtering on all fronts — consumer spending, job creation, business investment, housing and possibly even exports — and the downturn has only begun.

The Federal Reserve is within striking range of reducing the overnight lending rate to zero, a point that Japan reached in the 1990s and remained at for years while it struggled to revive its economy.

If the Federal funds rate were to reach zero, the Fed would not be out of tools for stimulating the economy. But it would have to resort to unconventional tools that it has never used before. Instead of trying to reduce rates on overnight loans between banks, for example, it might start buying longer-term Treasury securities in order to push those rates down.

The Fed’s biggest weakness at the moment is that the economy’s problems have less to do with interest rates than the reluctance of banks and financial institutions to lend money. Even though the Fed has loaned out almost $600 billion to financial institutions in the last month alone, banks are still reluctant to lend to businesses or consumers.

Since the credit crisis began in August 2007, the Federal Reserve has slashed the Fed funds rate from 5.25 percent to 1.5 percent. But interest rates for 30-year fixed-rate mortgages are about 6.3 percent, roughly where they were when the credit crisis began.

Many economists contend that the United States economy has already slipped into a recession that could well last longer and be more severe than any downturn since the early 1970s.

The crisis in financial markets and banking, which began more than a year ago and has choked off lending to corporations and consumers, is spreading to the broader economy. But credit remains tight, even though the Federal Reserve has tried to jumpstart credit markets by lending nearly $700 billion over the last month.

Both consumers and businesses have ratcheted back spending. Major corporations from General Electric to Coca-Cola have announced layoffs, and Detroit’s car makers are struggling to survive.

Consumer spending, which accounts for about two-thirds of the nation’s economic activity, appears to have declined in the third quarter and will probably remain low for some time. The Conference Board’s closely watched measure of consumer confidence declined in October to the lowest point in the survey’s history.

Private forecasters expect that the Commerce Department, which on Thursday will release its initial estimate of third-quarter growth, will report that the economy contracted about one-half of 1 percent. But most forecasters expect the fourth quarter to be worse.

The United States has been shedding jobs every month this year, for a total decline of more than 700,000 jobs so far. What makes that alarming to many analysts is that the job losses have come so early in the downturn.

Traditionally, companies have been cautious about laying off workers at the start of a downturn and equally cautious about adding workers after a recovery begins.

“The ground is moving from underneath us,” said Diane Swonk, chief economist at Mesirow Financial, an investment firm in Chicago.

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