Fed Cuts Rate by a Quarter Point, to 2%

WASHINGTON — The Federal Reserve reduced short-term interest rates for the seventh time in seven months on Wednesday, the latest in a series of measures it has taken to stabilize financial markets. The central bank lowered its federal funds rate — the rate it charges banks for overnight loans — by a quarter of a percentage point, to 2 percent from 2.25 percent.

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The New York Times

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The latest step by the Fed follows a period of unusual ups and downs in its interest rate policy in the last four years, as the economy has veered from an overheated state to its current downturn. In 2004, when fear of inflation was paramount, the Fed embarked on a succession of rate increases, pausing in mid-2006 at 5.25 percent.

It was then, however, that high interest costs helped burst the housing bubble, ushering in a period of defaults in subprime mortgages and shakiness among sub-prime lenders and mortgage holders. By July of last year, the Fed chairman Ben S. Bernanke was warning of a crisis in the subprime market.

As financial markets plunged in August, Mr. Bernanke led the Fed into its current phase of lowering interest rates. The Fed also pumped liquidity into the markets by making it easier for banks to borrow, and it began suggesting that it would do what was necessary to combat the tight credit market.

But even in the last six months, the Fed has offered mixed, and occasionally discordant, signals. In October, the Fed was still saying that inflation was as much of a concern as a recession. “The upside risks to inflation roughly balance the downside risks to growth,” it said.

In a somewhat embarrassing reversal, however, the Fed changed course after banks and financial institutions in Europe and the United States began writing off the costs of their bad housing loans. The Fed had to abruptly cast its inflationary fears aside, set up new lending facilities for troubled banks and inject more money into the markets.

The most recent crisis culminated in mid-March with the Fed’s extraordinary role in arranging the sale of the investment firm Bear Stearns to JPMorgan Chase, accepting $29 billion in mortgage-related securities as collateral in a deal that averted what Mr. Bernanke said was the possibility of a global panic in financial markets.

But the Fed’s actions in March were accompanied by internal disagreement as two dissenters known as anti-inflation hawks — Richard W. Fisher, president of the Dallas Fed, and Charles I. Plosser, president of the Philadelphia Fed — voted against the cut of three-quarters of a percentage point to 2.25 percent.

Some critics of the Fed’s policies say it has been too quick to respond to momentary trends and should have a more steady and stable policy of interest rate changes based on economic fundamentals.

“My view is that the Fed is back doing the silly things it did in the 1970s, of trying to make judgments that have long-term consequences based on short-term data,” said Allan H. Meltzer, professor of political economy at Carnegie Mellon University. “It should get back to the period of 1985 to 2003 known as the Great Moderation.”

The Fed’s recent move, coupled with the uncertain performance of the economy, appeared likely to deepen the partisan impasse in Washington over how to respond to joblessness, the mortgage crisis, energy costs and other problems.

Since the enactment of the $168 billion economic stimulus package earlier this year, Democrats and Republicans have increasingly accused each other of inaction. Mr. Bush is demanding that Democrats make permanent the tax cuts that expire at the end of 2010, and Democrats are pressing for an additional $30 billion in spending.

Noting that the first rebate checks have started to go out to Americans from the stimulus package already enacted, Mr. Bush and his aides argue that Congress should measure the effects of the stimulus, and lower interest rates, before taking further action.

There has also been no agreement on what to call the current economic downturn. The administration has avoided the word recession and will likely continue to do so after the anemic but still positive growth figures released earlier Wednesday. Many Democrats unhesitatingly say the United States is in a recession.

On Tuesday Mr. Bush said “these are very difficult times, very difficult.” Treasury Secretary Henry M. Paulson Jr. has said that despite progress in stabilizing the financial markets, the economic risks in the future are “to the downside.”

On Monday, the Treasury Department painted a gloomy outlook, noting that unemployment had reached a two-and-a-half year high of 5.1 percent last month, and that non-farm jobs were hit by the first quarterly decline since 2003.

Like many analysts, administration economists say that housing is the weakest part of the economy. But Mr. Paulson and his aides say that the sharp declines of prices, sales and new construction of homes reflects a “necessary correction” after years of an unsustainable bubble.

Housing starts and sales of new single-family homes fell to a 17-year low in March, the Treasury said, and starts of single-family homes had dropped by 63 percent from a peak in January 2006.

Congressional Democrats have been moving toward enactment of legislation aimed at helping the estimated two million homeowners in danger of defaulting on their mortgages in the next year. But the administration opposes the Democrats’ approach, which would widen availability of federally insured mortgages.

The White House favors “modernization” of existing programs and agencies as a better way to help homeowners.

Economists disagree over whether lower interest rates will by themselves spur a turnaround in housing or business investment.

Many specialists, for example, say that the larger problem of skyrocketing American indebtedness and the danger of weak banks and investment banks, as well as possible defaults in consumer debt, student loans and other forms of debt, are putting a damper on lending even as lending rates decline.

While many economists say that inflation has become as big a threat as a recession, especially because of soaring energy and food prices, the Bush administration maintains that “core inflation” — outside the energy and food sectors — has remained stable, at about the same range of about 2.5 percent that it has been in the last four years.