The Affects of the Fed's Rate Cut on Consumers - December 17, 2008

So what does yesterday’s Fed rate cut mean for the average consumer? In a statement made Tuesday afternoon, Fed Chairman Ben Bernanke confirmed the report that the government was reducing the federal funds rate from 1% to a range between 0% and 0.25%.

The previous rate of 1% was the lowest the rate had seen in more than 50 years. Nevertheless, with the country in a recession since last December, Bernanke needed to step in and halt the deterioration of the economy along with heading off the possibility of inflation.

The Fed rate is defined as the short-tern rate that commercial banks pay to other banks in order to borrow money. With lowered rates, consumers will most definitely see lower costs to borrow money.

In an immediate reaction to the Fed announcement, commercial banks responded by cutting their prime lending rate, the standard rate for millions of consumer and business loans, by 0.75% to 3.25%.

The financial crisis has reached out globally, as the European Central Bank recently reduced their interest rate from 4.5% in July to 2.5% this month. In addition, the Bank of England reduced their lending rate from 5.75% in July to 2% this month as well.

In many ways, the cut does benefit the average American consumer. The biggest impact the cuts will have will be on prime rate loans. These loans are tied directly to the prime interest rate. It would be here that home-equity line of credit and certain credit cards with variable interest rates are tied to the prime rate.

The home equity loans stood at 5.5% in October before the Fed made a 0.50%, which in turn dropped the rate to 5.26% for loans. Analysts believe that this rate will once again drop on the rate cuts. However, some may not be able to take advantage of the percentage decline because rates may already be at their lows.

However, long-term loans, such as mortgage rates, are less likely to be affected by yesterday’s rate reduction.

“What the Fed’s action seems to indicate is that they are willing to do whatever necessary to not allow our economy to collapse or continue in a recession for an extended period of time,” said Professor Lowell Broom from Samford University.

Announced late last month, a new Fed program was instituted to purchase $600B in debt and mortgage-backed securities from mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), which could be largely credited with having helped push mortgage rates down.

With the lending rate lowered, and the prices on cars and real estate continuing to decline, the price to borrow money for these purchases is considerably lower than this time last year.

Although the interest rates can’t go below zero, the next possible move for the Fed is to increase liquidity. To do this, the Fed would have to begin printing money and dispersing it into the money supply until they begin to see the economy start expanding once again.

The negative effect on printing more money and putting it into the supply means that it will weaken the Dollar even further against other major currencies.

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