The Federal Reserve cut its target interest rate Tuesday to historic lows between zero and a quarter percentage point and said it could expand a program of unorthodox lending and securities purchases.
Wells Fargo, Wachovia and U.S. Bancorp immediately lowered their prime lending rates from 4 percent to 3.25 percent, and other banks will probably follow suit. Economists cautioned, though, that people frightened by the economy and worried about their own jobs may not feel like taking on more debt.
After two days of discussion among Fed officials, the central bank said it would use every weapon from its arsenal to lift the U.S. from recession. It began by reducing its target interest rate -- an overnight bank-lending rate called the federal-funds rate -- from 1%. Another Fed lending rate, the discount rate, will go to half a percentage point, a level last seen in the 1940s.
The cut was more than many economists expected, and the statement that came with it marked the latest signal by the Fed and its chairman, Ben Bernanke, that the central bank was prepared to take aggressive steps to revive the economy.
"The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability," the Fed said in a statement. It added that it expected interest rates to remain "exceptionally" low for some time, a subtle commitment to the current policy that could help bring down longer-term interest rates.
In normal times, lower rates reduce the cost of borrowing for households, businesses and financial institutions, which spurs borrowing and economic activity. Those effects are being muted now, however, because many businesses and households are weighed down by heavy debts.
Still, stocks rallied on the news of the Fed's action. The Dow Jones Industrial Average finished at 8924.14, up 359.61 points, or 4.2%, on the day. Treasury bonds rallied, sending their yields lower. Yields on 10-year Treasury notes hit 2.269%. The dollar sank against the euro and the yen.
A number of official borrowing rates -- such as rates on three-month Treasury bills -- have tumbled to near zero, a level they haven't been near since the Great Depression.
President-elect Barack Obama used the Fed move as a rallying call for more fiscal stimulus, the idea of increased government spending or tax cuts, which Fed officials support.
"We are running out of the traditional ammunition that's used in a recession, which is to lower interest rates," Mr. Obama said in a news conference. "They're getting to be about as low as they can go. And although the Fed is still going to have more tools available to it, it is critical that the other branches of government step up."
The trouble for Fed officials is that while official borrowing rates are very low, interest rates for borrowers with even a modicum of risk remain far above levels of a few months ago, which is squeezing the economy.
Beyond lowering interest rates, the central bank said it could expand lending programs, including a plan to buy mortgage-backed securities. The Fed also said it was studying such rescue measures as purchasing U.S. Treasury securities, which could help reduce long-term borrowing rates.
Sixteen months into a campaign to lift the U.S. economy from a gathering financial storm, the Fed's efforts have so far failed, despite cutting interest rates more than five percentage points. In the latest example of the deepening recession, the Commerce Department said new home building dropped 19% in November, to a seasonally adjusted annual rate of 625,000 units, a record monthly low.
"The Fed gets an 'A' or 'A-minus' for effort and not very good marks for results," said Alan Blinder, a Princeton economist and former Fed vice chairman.
Meantime, consumer prices posted their second straight record monthly drop, with the consumer price index falling by 1.7% in November. Gasoline prices tumbled, while car dealers, retailers and others stepped up their discounting to move goods and sell services.
In a sign that inflation is decelerating sharply, core consumer prices, which exclude volatile food and energy prices, were unchanged in November. In the past three months, they have risen at an annual rate of just 0.4%.
Price declines have helped many consumers in the short run, but a longer-run bout of falling consumer prices could be dangerous, giving households even more incentive to slow spending and hoard cash.
Persistently falling prices also raise the real cost of borrowing for businesses and households, and thus Fed officials are determined to try to avoid it. A senior Fed official said after the meeting that the central bank isn't now worried about deflation, but expects the inflation rate to decelerate further.
Officials spent much of two days of meetings deliberating over what other rescue steps the central bank could take as interest rates approach zero. Mr. Bernanke spent much of his academic career studying that and other questions related to financial crises, and the Fed is now employing almost every prescription he laid out in the past.
The approach carries several risks. It could eventually lead to the opposite of the current problem: higher inflation. It also exposes the independent central bank to political meddling and to losses on loans. Then there's the risk that it won't work.
The Fed has already started a campaign to lend directly to damaged financial markets and companies -- nearly anyone with collateral. Its statement Tuesday said those efforts could "sustain the size of the Federal Reserve's balance sheet at a high level."
By such lending, officials have effectively concluded that if banks and financial markets won't extend credit, it will do part of the job for them.
Two large Fed programs are still being ramped up. In one, the central bank has said it will buy as much as $600 billion of debt issued or guaranteed by Fannie Mae, Freddie Mac and other government-backed mortgage businesses.
So far, the Fed has only committed $8 billion to those purchases. Officials were relieved that mortgage rates have fallen since announcing the program last month. Rates on a conforming 30-year mortgages have dropped to 5.28% from 6.64% since the Fed's last meeting, according to HSH Associates, a financial publishing firm.
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