An intensification of the housing correction and increased strains in financial markets prompted the Federal Reserve to lower key short-term interest rates today, the third consecutive meeting since September it has taken such steps.

The Federal Reserve’s Open Market Committee lowered its target rate for the federal funds rate by 25 basis points, to 4.25 percent. In a related action, the Fed’s board of governors approved a 25 -basis-point decrease in the discount rate, to 4.75 percent.

“Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending,” the committee said in a statement explaining the decision. “Moreover, strains in financial markets have increased in recent weeks. Today’s action, combined with the policy actions taken earlier, should help promote moderate growth over time.” 

On Sept. 18, similar concerns prompted the Fed to shave 50 basis points off the federal funds and discount rates. When the Fed governors met next, on Oct. 31, they made smaller, 25 basis point reductions in both rates — the same action taken today.

One member of the committee, Eric Rosengren — the president of the Federal Reserve Bank of Boston – today argued in favor of lowering the target for the federal funds rate by 50 basis points.

The federal funds rate is the rate banks charge each other for overnight loans. The Fed can influence the rate be easing or constricting the supply of money. The discount rate is what the Federal Reserve charges banks for short-term loans.

In slashing short-term rates at its last three meetings, the Fed is gradually reversing increases to the federal funds rate made during 17 consecutive meetings between 2004 and 2006. Those increases, instituted to cool the pace of economic growth, left the federal funds rate at 5.25 percent.

Lowering short-term interest rates stimulates economic growth by encouraging borrowing, but increases the risk of inflation and can devalue the dollar in relation to other currencies.

After the Fed cut its target for the federal funds rate to 4.5 percent in October, Federal Reserve Governor Randall Kroszner said the committee appeared to have found a balance that would allow moderate economic growth while keeping the risk of inflation in check (see Inman News story).

But in a speech at the end of November, Federal Reserve Chairman Ben Bernanke warned that renewed turbulence in financial markets had “partially reversed” improvements in September and October. Bernanke promised that the Fed would remain “alert and flexible” in making monetary policy decisions, leaving the door open for today’s rate cuts.


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