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Fed Lowers Another Key Interest Rate as Economy Slumps Graphic

December 19, 1990

WASHINGTON (AP) _ The Federal Reserve, amid fresh evidence of a weakening economy, lowered another key interest rate on Wednesday, analysts said. The Bush administration said it expected banks to follow the Fed’s lead to rejuvenate consumer borrowing, but there was no rush to do so.

Economists said the central bank injected reserves into the banking system to push the federal funds rate - the interest that banks charge to make loans to each other - to 7 percent. A day earlier, the Fed cut its discount rate, the interest it charges for direct loans to commercial banks, from 7 percent to 6.5 percent, the first reduction in four years.

The Fed’s action came as the Commerce Department lowered its already low estimate of the economy’s pace in the July-September quarter, putting the annual rate of growth in the gross national product at an anemic 1.4 percent.

Analysts said the downward revision in the GNP report showed that the country was facing severe difficulty even before the Iraq’s invasion of Kuwait battered the economy with soaring energy prices.

Many economists were looking for the fourth-quarter GNP report to signal the start of a recession, with some guessing that the contraction of output during the period could be as sharp as a 3.5 percent drop in GNP at an annual rate.

They base that estimate on a torrent of dismal economic news during the period from rising unemployment to falling industrial production and weak consumer sales.

It is these statistics that are prompting to the Fed to aggressively ease interest rates in the hopes that lower borrowing costs will spur such interest-rate sensitive sectors of the economy as housing and car sales.

Economists said that the reduction in the funds rate engineered - but not publicly confirmed - by the Fed on Wednesday amounted to only a 0.25 percentage point cut. It would be the fourth quarter-point cut in the funds rate that the Fed has spurred in the past two months.

On Wednesday, the Fed cut its discount rate, the interest it charges to make direct loans to commercial banks, from 7 percent to 6.5 percent.

While a cut in the discount rate is the most dramatic signal that the central bank can send of its desire to fight a slumping economy with lower interest rates, changes in the funds rate are considered just as crucial because of the impact they have on banks’ cost of funds.

Normally, the credit easing moves the Fed has made would be enough to spur banks to slash their benchmark prime lending rate, which is used as the basis for calculating many consumer and business loans.

However, the country’s major banks, who have been facing severe losses on bad real estate loans this year, showed no move toward making such a cut Wednesday although analysts said they still expected a reduction within days. The prime lending rate has been stuck at 10 percent since last January.

The Bush administration let it be known that it expected banks to do their part to spur a flagging economy. Presidential spokesman Marlin Fitzwater said that while a reduction in the prime rate was a ″market decision″ it was normal that ″a discount-rate cut reverberates through the system.″

The Commerce Department GNP report continued to revise downward economic growth for the third quarter. It initially estimated growth during this period at 1.8 percent in October, but revised that to 1.7 percent a month later.

The GNP is the nation’s total output of goods and services and its broadest measure of economic health.

Economist Kermit Baker of Cahners Economics in Newton, Mass., said the downward revision ″is a trajectory of where the economy is headed. It indicates the fourth quarter will be a lot weaker than the third.″

Bruce Steinberg, an economist with Merrill Lynch Capital Markets in New York, agreed, noting other government reports show ″the economy is falling rather rapidly in the fourth quarter″ and will continue to fall during the first part of 1991.

Highlighting the continuing deterioration, the department also reported on Wednesday that construction of single-family houses in November dropped to a level not seen since the 1981-82 recession even though the overall construction figure rose by 9.3 percent, solely because of a big increase in multi-family building.

The government reported Wednesday that a GNP measure of inflation was unchanged at an annual rate of 4.2 percent in the third quarter. That measure was expected to rise significantly faster in the final three months of the year given what energy prices did following Iraq’s invasion of Kuwait.

Contributing most to the downward revision in third-quarter GNP growth was weaker consumer spending and a wider trade deficit than first estimated.

Consumer spending was revised from a 3.6 percent annual rate of growth to just 2.7 percent while the nation’s trade deficit increase was boosted to $1.9 billion, more than three times higher than last month’s estimate.

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