Recent Fed Rate Cuts Impact Prime Rate
Federal Reserve Announcement - Reduced Target Federal Funds Rate
Dec 16, 2008
In a December 16, 2008 press release posted on the Federal Reserve website, the Federal Open Market Committee (FOMC) announced a fed rate cut. The United States Federal Reserve decided to establish a target federal funds rate of 0 to .25 percent.
Fed Rate Decision: Why Did the Federal Reserve Make Another Fed Rate Cut?
Cutting federal rates is one traditional way the Federal Reserve combats a recession. With news of a new fed rate cut, consumer confidence increases and the stock market typically responds in positive ways.
According to the press release, “Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.”
Deciphering the Fed Announcement: What Is the Federal Funds Rate?
The federal funds rate represents the interest rate at which depository institutions (i.e. banks) lend to one another. The target federal funds rate is announced after the conclusion of FOMC meetings (commonly known as “fed meetings”). The target federal funds rates announced from 1990 to 2008 can be seen on this Federal Reserve chart.
In July 1990, the rate was 8 percent. Since then, the federal funds rate has fluctuated. It was 1 percent in June 2003, rallied back up to 5.25 percent by June 2006, but returned to a low of 1 percent by October 2008. The December 16, 2008 announcement of a cut to .25 percent is an all-time low over the past 18 years.
What Is the Prime Rate? How Is It Related to the Federal Funds Rate?
The prime rate, which U.S. consumers are most familiar with, is tied to the federal funds rate. This means that when the federal funds rate increases or decreases, the prime rate typically follows suit.
According to the Wall Street Journal Prime Rate website, the United States prime rate is used by many banks to set rates on consumer loan products like student loans, home equity lines of credit, car loans, and credit cards. A change in the prime rate will most likely result in a rate change on variable interest rate credit cards or adjustable mortgages. A general rule of thumb is that the prime rate is the federal funds rate plus three percent.
Resources:
Federal Reserve website
Wall Street Journal United States Prime Rate website
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