Fed Lowers Target Federal Funds Rate

Federal Reserve Chair Ben S. Bernanke ’75 and the Federal Open Market Committee voted to slash the target federal funds rate, the overnight rate at which banks can lend to each other, by half a percentage point yesterday to four-and-three-quarters percent—a move that was met with moderate approval from Harvard’s economists.

In a statement, the Fed said that “the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally,” and lowered the rate in an attempt to “forestall some of the adverse effects” of the recent “disruptions in financial markets,”

Morris University Professor Dale W. Jorgenson said he felt that the cut was a predictable and sensible move.

“The economy has been limping along, most of which has been the housing crisis,” he said. “The Fed didn’t cut before because they were worried about inflation, which they should be.” Jorgensen said that in the wake of the subprime mortgage meltdown, “The Fed is sending the message, ‘we’re taking action, we’re on the job.’”

Senior Lecturer on Economics Jeffrey Miron said that he still would have liked to see Bernanke not do anything, but conceded that there were some reasonable justifications for the cut.

“I don’t like the argument that the Fed needed to prevent a further subprime lending crisis,” he said, “but if this is to stop the economy from slowing down, that is more defensible.”

Professor of Economics James H. Stock also sympathized with arguments for and against the cut.

“The Fed has to take a strong stance [against market freezes],” Stock said. “On the other hand, we can’t be in a situation where we’re bailing people out of bad decisions.”

The large cut was to some degree unexpected, as most economists and banks were predicting a quarter point drop.

“I thought [the cut] was going to be 25 basis points,” Stock said, using the financial term for one one-hundredth of a percent. “If I had thought it was going to be 50, I would have loved to take advantage of that.”

However, Jorgenson feels that the Fed still has room to cut further if it needs to.

“I thought it was likely they’d take a more gradual approach...but five-and-a-quarter percent is higher than one would expect for our current financial growth. The target for neutrality is about four percent—that’s reasonable.”

Stocks surged after the Fed announcement. The Dow Jones industrial average closed up 2.5 percent at 13,739.39 and the Standard & Poor’s index of 500 stocks closed up nearly 3 percent at 1,519.78.

—Staff writer Maxwell L. Child can be reached at mchild@fas.harvard.edu.