The Federal Reserve’s move to cut half a percentage point off a key interest rate Friday is likely to further shake consumer confidence and could lead to cuts in spending, a local economist said.
The cut in the discount rate — the interest rate the Federal Reserve charges on loans to banks — from 6.25 to 5.75 percent came after two weeks of losses and a near correction on the Dow Jones industrial average.
The Fed move sent stocks soaring Friday, with the Dow closing up 233 points to 13,079.08.
The Fed said it was “monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from disruptions in financial markets.”
The immediate impact of the cut is that banks are more willing to borrow money, making large market-moving deals more likely.
This helps solves the liquidity crisis Wall Street has faced in recent weeks.
The Federal Reserve did not, however, cut the federal fund rate, which is the rate banks charge to one another on loans.
Its statement did not rule out future action.
Had this rate been cut, it would have had a much greater effect on everyday consumers, as interest rates on prime mortgages would have dropped.
The discount rate doesn’t affect mortgage or credit card payments.
Economists said, however, that consumer confidence suffers when the Federal Reserve has to bail out the stock market.
“We’re going to see a slowdown in consumer spending,” said Joseph Cater, chief economist at Annapolis-based Market-Economics. “That’s where you’ll see the reverberations.”
Cater said a slowdown in spending — the primary driver of the economy — could be disastrous as the Dow tries to regain its footing.
University of Maryland business school professor Peter Morici said the rate cut was a psychological move in response to the lack of confidence in markets following the subprime mortgage meltdown.
“The Federal Reserve’s move today is partially intended to address that psychological issue,” he said. “If markets fail to respond positively today and hold those gains through next week, the economy will be in a crisis of confidence that is truly threatening to our prosperity.”
