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Why Fed Is Expected To Cut Interest Rates Again

AP
Monday, 10 Dec 2007 | 7:51 AM ET

A lot has changed since the Federal Reserve hinted two months ago that it might be finished cutting interest rates for a while.

Credit has become harder to obtain, Wall Street has convulsed again and the housing slump has intensified. As a result, policymakers at the central bank now appear to have changed their minds about the need to drop interest rates again.

Federal Reserve Chairman Ben Bernanke.
Mary Altaffer
Federal Reserve Chairman Ben Bernanke.

The Fed had cut rates twice this year and officials suggested in October that might be enough to help the economy survive the credit and housing stress.

Then the problems snowballed, leading Fed Chairman Ben Bernanke to signal that one more cut might be needed.

Analysts expect the Fed to trim its key rate, now at 4.5 percent, by one-quarter of a percentage point at the meeting Tuesday. Some even speculate about the possibility of a half-point cut.

Banks, financial companies and other investors who made loans to people with spotty credit or put money into securities backed by those subprime mortgages have lost billions of dollars. Investors in the U.S. and abroad have grown more wary of buying new debt, thereby aggravating the credit crunch.

All this has added to the turmoil on Wall Street, and Bernanke and other Fed officials say they must take it into account when deciding their next move.

But does lowering rates mean the Fed essentially is bailing out investors or encouraging more sloppy decision-making? In other words, what exactly is the Fed's job?

Bernanke and other Fed officials say it is to make policy that keeps the economy growing and inflation low, a stable climate that benefits individuals, businesses and investors. The Fed also has a responsibility to ensure the banking system is sound and financial markets run smoothly.

"There is a link between Wall Street and Main Street. The Fed is taking the right actions, but they should be careful," said Victor Li, an economics professor at the Villanova School of Business.

Fed, Economy & You
Debating whether Bernanke will deliver an early present and help kick-start the economy, with John Silvia, of Wachovia; Harry Clark, of Clark Capital Mgmt.; and David Leaver, of Forex.com

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