The Federal Reserve Bank's Open Market Committee (FOMC) lowered the federal funds rate 50 basis points this afternoon to 2.5%, the benchmark's lowest level since 1962. The announcement is the ninth rate cut this year as central bankers battle a slowing economy. Economic growth, as measured by the gross domestic product, has fallen from a 4.1% increase in the past two years to 1.3% in the first quarter of 2001 and 0.3% in the second quarter, the latter of which was the slowest uptake since the first quarter of 1993.
The outlook for the economy has worsened since last quarter, with many economists speculating even worse results in the next two quarters, particularly given the impact of the Sept. 11 terrorist attacks on businesses and consumers. Since Sept. 11 alone, major airlines like Delta
In its press release, the Fed said, "The terrorist attacks have significantly heightened uncertainty in an economy that was already weak. Business and household spending as a consequence are being further damped. Nonetheless, the long-term prospects for productivity growth and the economy remain favorable and should become evident once the unusual forces restraining demand abate." The Fed also approved a 50 basis point cut today in the discount rate -- the rate banks pay when they borrow from the Fed -- to 2%.
The federal funds rate, also known as the overnight rate, is the rate banks charge each other for overnight loans. It's significant in that banks are subject to reserve requirements -- a proportion of deposits depository institutions are required to hold in reserve -- and they often fall below those requirements throughout the course of a business day, forcing them to borrow from one another's reserves.
The FOMC move may bring more good news to homebuyers and homeowners. Lower federal funds and discount rates may lead to lower home mortgage rates, if they coincide with lower long-term inflation expectations. When mortgage rates decline, renters may find home-buying more affordable, and homeowners may be able to save money through refinancing their mortgages to obtain a smaller monthly payment. (The Fool's got all the worksheets and calculators to help you with every part of home-buying and refinancing.)
In addition to lowering the cost of debt, the Fed's announcement was also likely meant to encourage confidence among businesses and consumers, which has fallen as a result of the recent terrorist attacks. The Monday after the attacks the Fed wasted no time in lowering the federal funds rate from 3.5% to 3%, and although many economists are predicting an economic recovery next year, many onlookers expect another rate cut by the end of year. For more information on the Fed, check out the Motley Fool's special feature.
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