Fed Slashes Key Rate, Will Lend to Hard-Hit Countries

Nonetheless, many economists think the Fed will cut the rate again at its Dec. 16 meeting, if not before, as the economy worsens.

"We're in a downward spiral that's going to take at least six months to get through," said Kurt Karl, chief U.S. economist at the reinsurer Swiss Re, who expects the Fed to cut the rate to half a percent. "The next time they meet, the situation may be better in the credit markets, but the economy is going to be very dire."

The Fed did little to dissuade that thinking in its statement, as it indicated that inflation is likely to moderate and that it will "act as needed" to promote growth, language that leaves the door wide open to further actions. The Fed's decision to cut the rate was unanimous.

The central bank is facing a situation in which additional rate cuts are unlikely to pack much additional punch, both because rate moves normally take time to affect the economy and because credit markets remain clogged. Nonetheless, Fed leaders have felt it necessary to deploy every possible tool they have to combat the downturn.

The aggressive rate cuts -- the central bank has cut the federal funds rate to 1 percent from 5.25 percent in September 2007 -- create two risks. If the economy recovers faster than expected, it could stoke a new lending bubble, which happened in the early 2000s and contributed to the current crisis.

On the other side, if things turn out worse, the Fed could find itself with little room to maneuver -- interest rates cannot be pushed below zero (and indeed could cause problems in the functioning of money market mutual funds and other investment vehicles if brought down to zero).

"You could be left with no defense," said Richard Yamarone, chief economist at Argus Research. "What happens if the Fed does cut to zero and then the economy early next year contracts 3 or 4 percent? It has no bullets left in the chamber."

By offering new loans with flexible terms, the IMF, a multilateral lender funded largely by the world's richest nations, is effectively breaking with decades of highly methodical lending that came with tough conditions. Typically, the fund grants loans only after weeks, if not months, of negotiations, and demands major concessions from borrowing nations on spending and economic reforms.

But the crisis is such that the IMF needed to take extraordinary steps, Strauss-Kahn said. Only nations viewed as fundamentally sound and with good relationships with the fund can participate in the program.

The short-term loans would have three-month terms, in contrast with the three- to five-year terms of typical IMF loans. A formula would limit the amount each nation could borrow; Brazil, for instance, could borrow about $15 billion at once, though it could do so as many as three times a year, assuming each loan was paid back in full.

Countries deemed not to have good track records and fiscal policies, such as Argentina, Strauss-Kahn said, would not be eligible.

In an interview, Strauss-Kahn said the fund would probably need more money from its international donors to address the mounting problems in emerging markets. The IMF has about $200 billion, with access to another $50 billion, to lend. But as the crisis has hit emerging markets, the IMF has promised $2.1 billion to Iceland, $16.5 billion to Ukraine and $15.7 billion to Hungary. Deals are pending with Pakistan and others.

British Prime Minister Gordon Brown has called for China and the oil-rich Gulf states to contribute new, vast sums to the IMF. Strauss-Kahn would not confirm that the fund had entered into talks with those nations for an infusion, but he said he would "welcome" a move by nations with "big pockets" to aid those now in crisis.