Federal Reserve Slashes Rates - Again!

The Federal Reserve announced today (3/18/08) that it cut the discount rate, from 3.25% to 2.50%. The Fed also cut the Fed funds rate from 3.00% to 2.25% in an attempt to restore confidence to nervous financial markets and boost the ailing economy. The discount rate is the interest rate that an eligible depository institution is charged to borrow short-term funds directly from a Federal Reserve Bank. The Fed funds rate is the interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight.

These actions along with the reduction in rates made on 1/22, 1/30 & 3/16 indicate strong action to restore confidence to the financial markets. The latest interest rate reductions by the Fed made on 3/16 & 3/18 were designed to prevent a financial panic due, in great part, to the financial woes of Bear Stearns (see my previous posts dated 3/15 & 3/16 on this subject).

US Treasury Secretary Henry Paulson stated on Tuesday that the economy was facing a "sharp decline" at the moment, but he also stated that, based upon these actions by the Treasury and Fed, he hopes for a recovery later in the year. It is hoped that these measures will restore the confidence of investors in the stock market as well as prevent further declines in the financial markets.

The basic premise behind these Fed rate reductions is simple – decrease the cost of borrowing and it should result in stimulating the economy as people are induced to borrow and spend. The Fed has made a series of bold rate reductions since August of 2007 when the discount rate was 6.25% to where it is now at 2.50%. During this same period, the Fed funds rate went from 5.25% down to 2.25% - as of today with the latest reduction.

Some economists are concerned that with these rapid rate reductions it may leave the Fed with few options in the future if the economy doesn’t favorably react to these rate cuts. However, many economists are confident that given the aggressive and rapid rate reductions made, it will have the intended effect of stimulating the economy over time and greatly limit any further downside risk.