Interest-Rate Drop Is Called A 'Positive Step' Fed Cut in Discount Rate This Week Is Aimed at Encouraging Consumers, Banks, to Spend. FEDERAL RESERVE BANK

By Scott Pendleton, writer of The Christian Science Monitor | The Christian Science Monitor, November 8, 1991 | Go to article overview

Interest-Rate Drop Is Called A 'Positive Step' Fed Cut in Discount Rate This Week Is Aimed at Encouraging Consumers, Banks, to Spend. FEDERAL RESERVE BANK


Scott Pendleton, writer of The Christian Science Monitor, The Christian Science Monitor


THE Federal Reserve can lead bank customers to lower interest rates, but it can't make them borrow.

That's the reaction of many economists and businessmen to the Fed's latest cut in its discount rate, which aims to promote spending in order to accelerate the pace of recovery from the 1990-91 recession.

The rate cut is "a positive step that improves the consumer's ability to finance new cars. The uncertainty is what kind of effect that will have on the consumer's willingness," says Terry Sullivan, a spokesman for General Motors Corporation, which along with the auto industry as a whole has been starved for sales.

"This will help, but it's not going to be anything dramatic," adds Richard Peterson, chief economist at Continental Bank in Chicago. Concern over the economy is making consumers cautious about spending, he says.

The discount rate is the interest rate that the Fed charges member banks for loans. Adjustments to the rate are a strong signal of monetary policy: downward to stimulate economic growth; upward to arrest inflation. Banks generally adjust their own interest rates accordingly.

On Wednesday the Fed set the discount rate at 4.5 percent. That was the fifth rate reduction since Dec. 17, when it was 7 percent, and the lowest it's been since 1973. A number of major banks quickly announced similar cuts.

The initial effect of lower interest rates is smaller repayments on floating-rate debt. The effect is staggered because interest rates on corporate borrowings, for instance, might be recalculated every month while the rates on some mortgages are adjusted only once a year.

"For {every} person who's paying less interest there's {a} person who's receiving less interest," notes Steven Strongin, an economist with the Chicago Fed. But the economy still gets a boost because a decline in interest income doesn't curtail spending plans as much as a decline in interest costs stimulates spending by making debt more affordable.

Individual debtors will use the savings to pay off debts faster, bank it, or take it shopping.

"That's exactly what the Fed is trying to engineer here," says Wayne Ayers, chief economist at the Bank of Boston. "Even debt reduction improves net worth and over time that puts the consumer in a better position to spend."

Businesses are likely to bank their own interest rate savings until the extra dollars from consumers begin flowing in. Then they will consider spending to expand operations. …

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