The Central Bank Cuts the Federal Funds Rate: What does this mean?
The Federal Reserve again lowered a key interest rate by .5% to 1%. This interest rate is called the “federal funds rate” which is the interest banks charge each other on overnight loans. From an historical perspective, this rate has not been lower since 1958 and represents an aggressive move by the Fed to restore confidence in the market and stimulate banks to make loans.
But here’s an important question: What impact does this interest rate cut have on the consumer’s mortgage rates, credit card interest or other loans? Does a reduction in this rate matter? Will home owners in Seattle, Kenmore or New York City be able to get a better rate on their mortgages? Well, the short answer is yes. In the long-term the theory is that lowering this interest rate exerts downward pressure on the whole economic system resulting in lower consumer interest rates. I have a colleague who has a degree in economics to whom I posed this question. He confirmed that the overall strategy of the Fed lowering the rate is intended to stimulate lending. He said there’s a fancy economics term called the velocity of money that applies here. However, he believes the the Fed is lowering the rates because there is a total lack of confidence and trust between the large lending institutions. ”It’s really about psychology,” he said. My friend also said something I think is critical: “If a consumer has good credit and the right amount of cash, they can still buy a house even in the current economy!”
So what does this all mean? The Federal Reserve has a number of “tools” to help influence banks and stimulate lending. Today they sent a clear message that action is needed and they will be monitoring the results of the interest rate cut. Let’s see what happens.
A special note: I am not an economist.
