What’s Up With My Economy?

A look at what the central banks’ rate cuts mean for the economy and for you.

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The Federal Reserve joined today with five central banks around the world in an uncommonly concerted round of interest rate cuts meant to bolster confidence in the markets and improve access to credit. In explaining its half-point cut to 1.5 percent, the Fed pointed to recent turmoil in the markets and economic data that show a marked slowdown in recent months. "Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of household and businesses to obtain credit," the Fed said in its announcement.

A look at what today's news means:

Why did the central banks cut rates all at once?
Welcome to the global economy. The economic slowdown isn't a U.S.-only problem. Confidence has been eroding in the global financial system, and stock values plummeted early this week in exchanges around the world. The Russian government halted trading at its main stock exchange after the index fell 14 percent in this morning's trading—the sixth straight day of losses. Japan's Nikkei exchange is now at its lowest level in five years. The Dow Jones industrial average has retreated to levels last seen in 2003. This isn't the first coordinated rate cut, though: The Fed cut rates in concert with the European Central Bank after the terrorist attacks of Sept. 11, 2001.

What are the interest rate cuts expected to do?
The rate cuts are expected to increase the flow of credit to lending institutions and free up capital for their borrowers. In a morning note, economists at Goldman Sachs said the cut was "helpful at the margin for growth and underscores the Fed's commitment to use all available tools to deal with the current situation."  It may be mostly something of a morale booster—displaying the extent to which central banks are prepared to heal the markets. Many economists are anticipating additional rate cuts—starting with the Fed's next meeting October 28–29.

Weren't we worried about inflation?
In short: Yes, we were. When the Federal Reserve stopped slashing rates in April, leaving the key federal funds target rate at 2 percent, it halted a cutting spree that had begun in September 2007, as mortgage defaults and slower housing sales had begun to mire the market and injure access to credit. The credit fears by April had given way to worries about inflation as commodity prices spiked. (Remember corn protests in Mexico and pundits predicting $200-a-barrel oil?) Six months later, the Fed's inflation worries have eased, as prices of energy and other commodities have slipped back.

Will my 401(k) be in better shape by the end of today?
You may need to extend your horizons a bit further. The rate cuts didn't immediately spark a Wall Street rally as investors feared the central banks' moves would not ease the credit market freeze. "The problem isn't that rates are too high—the problem is that people just distrust each other," says Richard Yamarone of Argus Research. "Unfortunately, it's going to take a while to clean up."

So, will this make it easier for me to borrow money?
Is that really what you want? Consumers have actually started borrowing less. The Fed reported yesterday that the amount of outstanding credit in the United States had dropped for the first time in 10 years to $2.577 trillion. Yamarone says the coordinated rate cuts are largely a symbolic "confidence measure." He does not expect the Fed's action to affect mortgage rates tied to Libor.

But, yes, there is some good news: The prime rate—often used on car and home equity loans—is already easing. Several large banks quickly matched the Fed's half-point cut.

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economy
interest rates
global economy