Why The Federal Funds Rate Was Cut

Today the Fed announced a bold 1/2 point cut in the Federal Funds Rate, setting it at 4.75%. The Federal Funds Rate (FFR) is the rate at which commercial banks charge one another for overnight loans of one million dollars or more, and is generally considered to be the barometer of short-term interest rates.

What effect does this move have on the economy and why was it made? Well. Big questions often deserve little answers, so:

in a nutshell, lowering interest rates encourages borrowing – and so also spending – and this creates a lot more movement in the economy. When the economy shows signs of stagnating or freezing, lowering key interest rates like the FFR can stimulate movement.

The effects of this “subprime mortgage blowout” or whatever you want to call it are a lot more serious than you’d want to think. It means that not only are hundreds of billions of investment dollars being lost, not only are hundreds of once-mighty financial firms sinking into bankruptcy oblivion, but also tens of thousands of American families have been abused – I want to use strong language here and say financially raped – by disgusting, rapacious and thoroughly unethical (though, sadly, quite legal) lending practices. This kind of thing has a profound effect on the morale of a nation. What with the debt crisis that’s already facing our country, the event of this subprime mortgage blowout signals the real possibility of a financial crisis and economic recession in America, and by lowering the FFR Bernanke & Co. are hoping to avoid the financial freeze that will occur if everyone gets scared and stops spending their money.

On the other hand, we shouldn’t be too worried yet. The economy has been booming for almost six years – since the strangely rapid recovery from 9/11 – and our country is, historically speaking, quite overdue for a recession. Bush’s politics do have a knack for making sensitive people feel dirty, but his reign seems to have done wonders for the economy. In the short term. Recessions are normal, and necessary motions of the economy. The next one, being rather overdue, may come very soon, and it may be a little more severe than usual.

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