A listener from Indonesia named Efendy asks why the Federal Reserve is so important and how it works. This week offered a good example.
The Federal Reserve System is the United States central bank. Its Federal Open Market Committee, led by Fed chairman Ben Bernanke, makes monetary policy. It makes decisions that affect the cost of money and credit in the economy.
|A television at the New York Stock Exchange shows the actions of the Federal Reserve|
On Tuesday the committee lowered its target for the federal funds rate to four and three-quarters percent. This rate is what banks pay other banks to borrow money overnight. It was the first cut in four years.
Major banks including Bank of America, Wachovia and Wells Fargo soon followed with cuts in their prime rate. This is what banks charge their best customers.
Financial markets expected a rate cut from the Fed. But the size -- fifty basis points, or half a percentage point -- was double what many people expected. And it persuaded many that the Fed is more concerned about the possibility of a recession than about inflation.
Such concerns rose earlier this month on news that in August the economy lost jobs for the first time in four years. That added to worries about the housing finance crisis.
The committee said economic growth was moderate during the first half of the year. But it said the reduced availability of credit could intensify the current housing problems and restrain economic growth. The policy makers also said that some inflation risks remain and will be watched carefully.
The Fed's action will help some homeowners and other borrowers. What is not clear, though, is how much it will do for many homeowners facing sharply higher payments. Their payments on adjustable-rate mortgages will still go up, though not as high as they would have.
By the end of next year, an estimated two million or more holders of subprime loans will have their rates reset higher. These loans were made to people with weak credit histories.
The Fed also cut its discount rate for direct loans to banks by half a point, to five and one-quarter percent, to increase their lending ability. The traditional opinion of borrowing from the so-called discount window was that it represented a sign of weakness.
Stock markets rose sharply after the Fed cut interest rates. But not everyone was so pleased. Some experts warn that cutting rates could raise inflation. They also say it helps those who made unwise borrowing decisions.
And that's the VOA Special English Economics Report, written by Mario Ritter. I'm Jim Tedder.