With all the buzz about Federal Reserve Board Chairman Alan Greenspan cutting interest rates to stimulate the economy, one question lingers: What does it all actually mean?
The cuts-announced last month-lowered the federal funds rate from 6.5 to 5.5 in two half-point decreases. January’s cuts mark the first time since Greenspan was appointed chairman in 1987 that the federal funds rate has been cut by a full percentage point in a single month.
The federal funds rate is the lowest of short-term market interest rates, or the rate on interbank loans. This differs from the interest rate, with which most students are familiar, such as interest on credit-card balances.
“The federal funds rate is the daily interest rate that banks charge each other,” said Jack Strauss, associate professor of economics at Saint Louis University. “Banks can then lower their prime rates, passing those savings on to consumers.”
Dropping the interest rate is a key way to stimulate the economy, which after peaking during the past decade, has recently slowed.
“The economy is slowing down because of surpluses of inventories, mostly centered in the manufacturing sector,” Strauss said.
Though the services sector remains at large, inventory surpluses proved detrimental to the manufacturing sector as consumer sales declined.
Greenspan stated earlier this month that economic growth is “very close to zero.”
He has also stated that the economy is currently not in recession and that a full-blown recession is unlikely.
“Most economists forecast that the United States’ economy will slow down but not have a recession,” Strauss said.
Lowering the federal funds rates may also stimulate other results indirectly.
Capital costs may be cut, encouraging businesses to expand. Consumers may also be less hesitant to invest in major expenditures, such as real estate and automobiles.
In contrast to lowering rates, a rise in the federal funds rate helps to suppress inflation.
Such action was seen last year when the Fed raised rates six times over an 11-month period ending in May 2000.
As far as college students are concerned, lowering the federal funds rate will not have a significant, direct impact on them. All students are tied to the economy, as there is a correlation between the economy and the job market. However, Strauss said, “On a day-to-day basis, a typical student would not be directly affected.”
Greenspan’s testimony before the U.S. Senate on Tuesday stirred speculation that further rate reductions are likely.
The Fed believes that the economy will grow by approximately 2 percent, to 2.75 percent this year. Greenspan’s forecast last July had projected growth from 3.25 percent to 3.75 percent.
Unemployment is estimated at 4.5 percent by the end of the year.
