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How does Fed's interest move rate?

By HELEN HUNTLEY, Personal Finance Editor
Published December 12, 2007


What did the Federal Reserve do Tuesday?

The Fed cut a key short-term interest rate by a quarter of a percentage point, to 4.25 percent.

Why did the Federal Reserve cut interest rates again?

Because the economy has slowed so much that officials are worried we might slip into a recession and, at the least, because the credit crisis could be hurting the broader economy beyond housing.

How does the interest rate cut help?

It makes it cheaper for consumers and businesses to borrow money, allowing them to spend more. However, that's somewhat offset by the fact that credit standards have tightened, making fewer people eligible for loans at the best rates. Lower rates also will make payments more affordable for some homeowners whose adjustable-rate mortgages are poised to reset.

How soon will loan rates drop?

Rates will drop right away on new loans tied to the prime lending rate or the one-year Treasury bill. However, there won't be any immediate impact on loans tied to the London Interbank Offered Rate (known as LIBOR), which has remained high. If you've already got an adjustable-rate loan, its terms will tell you when rates reset. On fixed-rate loans, the rate cut should mean lower rates on short-term loans (such as car loans and credit cards) for people with good credit.

What about savings rates?

Rates on money market funds and certificates of deposit will trend downward. However, shopping around will pay off because some banks remain willing to pay more to attract deposits.

Are there any drawbacks to a rate cut?

Low rates provide fuel for inflation and also contribute to the weakness in the dollar.

Why did stocks drop so much Tuesday after the rate cut?

Some investors were hoping the Fed would be more aggressive and cut rates a half percentage point instead of a quarter.