Why Did the Fed Cut Rates to Near Zero?
The Federal Reserve's move won't impact the economy right away, but that's not the point
The Federal Reserve on Sunday announced a steep cut to short-term interest rates, as well as a commitment to buying several hundred billion dollars of longer-term debt to lower long-term rates.
Cutting rates to near zero and launching a so-called quantitative easing program are moves straight out of the Fed's playbook from the Great Financial Crisis.
The question, then: Why is the Fed using the same moves today when the economy is reeling for very different reasons? After all, the financial system is seizing up because of a demand shock, not a credit crisis. Easy money in the form of cheap mortgages and car loans won't make it safe for folks to venture out of their homes.
From just $107.88 $24.99 for Kiplinger Personal Finance
Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
But that's not what the Fed was trying to achieve when it dropped the Fed funds rate, its benchmark interest rate, by a full percentage point to a range of 0% to 0.25%.
Rather, in the words of University of Oregon economist and Fed expert Tim Duy, "It was time to go big or go home."
The Fed already took steps to stabilize the government bond market last week when it wasn't functioning well because of a lack of liquidity. (Liquidity allows market participants to buy or sell securities when they want at close to the prices they want.) The central bank made $1.5 trillion in short-term loans available to bond dealers and launched a wave of Treasury purchases.
By following those initiatives with a massive rate cut and QE program, the Fed sent a critical message to investors, says Duy: "The aim is to act as a buyer of last resort following the deterioration in liquidity across the Treasury market. The Fed basically signaled as clear as it could that it was ready to backstop the financial markets."
"I am thinking (Fed chief Jerome) Powell is not going to let another Lehman Brothers happen on his watch," Duy adds.
Powell admitted Sunday night that the rate cuts wouldn't have an impact on the economy at this time. That's not the intent. Monetary policy is limited in what it can achieve when the issue is a demand shock.
What will help right now is accommodative fiscal policy. In plain English, that means the president and Congress need to step up and approve spending programs that can help blunt the impact of this disaster. Loose monetary policy can support fiscal policy by lowering the government's borrowing costs with ultra-low interest rates. For example, the yield on the 10-year Treasury note stands well below 1%.
"In the near term we really need fiscal stimulus," says Duy. "The Fed has paved the way, but they can’t make Congress and the president follow their lead."
The Fed's rate-cutting actions aren't meant to have much visible impact now. They're intended to help us rebuild once the war against COVID-19 is over.
-
Should You Renew Your CD?With rate cuts impacting earnings, we examine if now is a wise time to renew CDs.
-
7 Ways to Plan Now to Save on Medicare IRMAA Surcharges LaterUnderstand the critical two-year lookback period and why aggressive planning before you enroll in Medicare is the most effective way to minimize IRMAA.
-
Law Reversal Looming? Trump Eyes 2026 Gambling Winnings Tax ChangeTax Deductions It's no secret that the IRS is coming after your gambling winnings in 2026. But how long will that last?
-
The Delayed November Jobs Report Is Out. Here's What It Means for the Fed and Rate CutsThe November jobs report came in higher than expected, although it still shows plenty of signs of weakness in the labor market.
-
December Fed Meeting: Updates and CommentaryThe December Fed meeting is one of the last key economic events of 2025, with Wall Street closely watching what Chair Powell & Co. will do about interest rates.
-
If You'd Put $1,000 Into Coca-Cola Stock 20 Years Ago, Here's What You'd Have TodayEven with its reliable dividend growth and generous stock buybacks, Coca-Cola has underperformed the broad market in the long term.
-
If You Put $1,000 into Qualcomm Stock 20 Years Ago, Here's What You Would Have TodayQualcomm stock has been a big disappointment for truly long-term investors.
-
The Delayed September Jobs Report Is Out. Here's What It Means for the FedThe September jobs report came in much higher than expected, lowering expectations for a December rate cut.
-
If You'd Put $1,000 Into Home Depot Stock 20 Years Ago, Here's What You'd Have TodayHome Depot stock has been a buy-and-hold banger for truly long-term investors.
-
October Fed Meeting: Updates and CommentaryThe October Fed meeting is a key economic event, with Wall Street turned into what Fed Chair Powell & Co. did about interest rates.
-
The Delayed September CPI Report is Out. Here's What it Signals for the Fed.The September CPI report showed that inflation remains tame – and all but confirms another rate cut from the Fed.
