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News Analysis: Why US Federal Reserve Continues to Cut Rates
A persistently weak economy at home and slowing economic growth abroad have forced the US Federal Reserve to reduce its benchmark interest rate for the seventh time this year on Tuesday in a fresh effort to keep the economy out of a looming recession.
After a meeting on Tuesday, the central bank's policy-making body, the Federal Open Market Committee, announced that it decided to cut the federal funds rate, which financial institutions charge one another on overnight loans, by one quarter of a percentage point to 3.50 percent from 3.75 percent.
Meanwhile, it also reduced the largely symbolic discount rate by the same margin to 3.00 percent from 3.25 percent.
Combined with six previous rate cuts since the beginning of this year, the move represented the most aggressive credit easing campaign by the central bank for nearly two decades, including five straight half-percentage-point cuts.
The campaign resulted in an accumulated reduction of 300 basis points in federal funds rate, which has therefore dropped to the lowest level since spring 1994.
The fresh rate cuts came against the backdrop of an increasingly intense debate among analysts over whether the US economy was poised for a turnaround or slipping into a full recession. There have been some mixed signs, both good and bad, about the US economy in recent months.
On the one hand, housing activity keeps increasing and new claims for unemployment insurance have ceased to further go up. Meanwhile, the industrial production, which had been declining for seven consecutive months since the second half of last year, held steady in July. All this indicated that the U.S. economy may be bottoming out.
On the other hand, however, surveys show that most manufacturers' orders are still falling and profit projections remain in free-fall. Some areas of previous strength, such as commercial construction and auto sales, are also weakening. Policy- makers at the Federal Reserve are concerned by a slipping global economy, especially the flagging performance of the European economy and the economic woes of Japan.
A recession is defined as two consecutive quarters of declining economic output, or gross domestic product. This hasn't happened yet. But latest official statistics show that the United States' gross domestic product, which registered a sluggish 1.3 percent annual rate in the first quarter this year, reduced to an anemic 0. 7 percent in the second quarter.
Some analysts believe that related figures may be revised down as more data become available, perhaps falling into negative territory reflecting an actual decline in economic output. This signifies that the US economy is still struggling to stay out a full-fledged recession.
With the US economy still facing the risk of slipping into a recession, the Federal Reserve decided to cut the rates further in a bid to build consumer and business confidence and create some optimism among investors.
In a statement explaining its action, the Federal Open Market Committee said on Tuesday that "business profits and capital spending continue to weaken and growth abroad is slowing, weighing on the US economy."
One reason the Federal Reserve sticks with quarter-percentage-point, rather than half-point, cuts this time is that there usually is a time lag between the rate cuts and response from the business circles. Federal Reserve officials believe that businesses need time to work off their excess inventories and absorb their unneeded production capacity, processes that likely would not be accelerated by bigger cuts.
There are seven cuts already in less than nine months. But analysts are still divided over whether these are sufficient to stimulate the U.S. economy heading toward a rebound.
"Although long-term prospects for productivity growth and the economy remain favorable, the Committee continues to believe that against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future," the Federal Open Market Committee said in its statement.
The message was widely interpreted as that the Federal Reserve still perceives excessive weakness, rather than inflation, a bigger threat to the US economy. This triggered speculations that the central bank may consider further rate cuts in due course later this year.
Bill Dudley, chief US economist at Goldman Sachs Group Inc. in New York, is one of the analysts who believe that the Federal Reserve is unlikely to leave rates unchanged given the weakness in the equity market and the improvement in the inflation outlook.
Some analysts and economists, however, insisted that the Federal Reserve, while leaving the door open for further rate cuts, is actually taking a wait-and-see attitude.
They believe that the businesses and markets need another strong stream of data points to really come to a better view of where the economy stands.
For several reasons, many forecasters and policy-makers expect to see an economic pickup before the end of this year. Up to June this year, unsold goods or inventories have been dropping for five consecutive months. Meanwhile, the earlier rate cuts should start having an impact. Personal income tax rebates and a large drop in energy prices have left consumers with more money to spend.
Analysts believe that the Federal Reserve's decisions on making additional rate cuts later this year will largely depend on whether and when there are signs of a rebound on the horizon.
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