Fed Rate Cuts: How Low can they Go?

Usually, a Fed funds rate cut of even a quarter percentage point is extreme.  But within the past few weeks, the Fed has slashed rates by half a point, not just once, but twice. Now that rates stand at a half-century low mark, economists wonder how much lower Fed Chairman Bernanke can go from here.

About a year ago, the Fed funds rate was 5.25 percent, and that was considered a bargain. But last January, which was eons ago in terms of world financial history, the Fed rates were just 4 percent. Then, Ben Bernanke and his colleagues began one of the most aggressive cutting campaigns in Fed history, slashing the Fed funds rate by three-quarters of a point in one emergency move, and a half point in another. Rates finally settled at 3 percent by the end of January. Those wild cuts were meant to stave off a pending recession, avoid inflation, and save the housing market by putting an end to foreclosures.

Sounds familiar, doesn't it? Now, the Fed has just implemented two back-to-back rate cuts of a half point each, so they currently match a half-century low of 1 percent. Bernanke did it for the same reasons cited above-to save the economy and the real estate industry.

Already skimming the bottom

This time, nobody really expects rate cuts to solve much in the short term. Fear and uncertainty rule the global markets for a variety of complicated reasons, and Americans will probably need the bitter medicine of a recession in order to cure what ails them.

When Warren Buffet was recently asked how low interest rates could go and still have any significant effect, for example, he indicated that the effectiveness of such a Fed move is limited. With his folksy wit and ability to communicate complex ideas in language that regular people can understand, he said that when they get down this low, cutting them is like jumping off a pancake. You just don't get very far.

Thawing a paralyzed market

The last time rates were at 1 percent was between 2003 and 2004. Some blame those rates on inflating the housing price bubble, but today's cuts are primarily intended to thaw the paralyzed loan markets. Japan left its rates at zero for most of the 1990s, but moves that low usually don't help much.  In addition, they tend to hurt confidence, because they make the Fed look desperate. The Fed funds rate may go lower but, at this point, it will have less significance than other tools that Bernanke might use, such as buying commercial paper, investing in bad bank loans, or offering another economic stimulus package to taxpayers and businesses.