After several months of public pronouncements and subtle hints, the Federal Reserve lowered the federal funds "overnight" rate from 6.5 to 6 percent yesterday. The cut -- larger than many experts expected -- essentially reduces the cost of capital to banks and thus means lower costs for borrowers.

The Fed also cut the "discount" rate, the rate regional Federal Reserve banks charge commercial banks for short-term loans, by one quarter of a percentage point to 5.75 percent.

The move immediately sent stocks soaring, with the Dow up more than 300 points in late afternoon, while the smaller NASDAQ rose almost as much.

"These actions," said the Fed, "were taken in light of further weakening of sales and production, and in the context of lower consumer confidence, tight conditions in some segments of financial markets, and high energy prices sapping household and business purchasing power. Moreover, inflation pressures remain contained. Nonetheless, to date there is little evidence to suggest that longer-term advances in technology and associated gains in productivity are abating."

The Fed moves are expected to have widespread impact throughout the economy. Lower loan costs will dampen inflation, increase spending (because more can be borrowed), and create new jobs (because more will be consumed). No less important, a further drop in mortgage rates is likely because the interest available to investors from alternative notes and bonds will now decline.

The Fed move also means the cost of government debt will fall, thus increasing the size of the surplus The result is likely to be further reductions in the deficit as well as renewed calls for tax relief.

"This action was sorely needed. The economy has been showing signs of serious weakening, financial markets have been in turmoil, consumer confidence has fallen and our own builder surveys have indicated a weakening in the housing sector," said Robert Mitchell, a home builder from Rockville, Md., and president of the 203,000-member NAHB. "We applaud this bold move by the Federal Reserve."

Published: January 4, 2001

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