The Federal Reserve Board, concerned about the weak economy but encouraged by the decline in inflation, yesterday lowered its discount rate from 9 1/2 percent to 9 percent effective Monday.
Financial markets had been expecting and hoping for the move for several weeks. Analysts said the action should lead to lower short-term rates generally, including a drop in the 12 percent prime lending rate at major commercial banks.
It was the sixth one-half percentage point decline in the discount rate -- the rate charged on loans made by the 12 Federal Reserve district banks to financial institutions -- since July. The action brought the rate to its lowest level since Nov. 1, 1978, when it was increased from 8 1/2 percent to 9 1/2 percent as part of a package of policy changes made to strengthen the U.S. dollar on foreign exchange markets.
In a statement, the board said, "The further one-half point reduction in the discount rate, which is broadly consistent with the prevailing pattern in market rates, was taken against the background of continued progress toward price stability, and indications of continued sluggishness in business activity and relatively strong demands for liquidity."
The board acted in the wake of a meeting Tuesday of the Federal Reserve system's top policymaking group, the Federal Open Market Committee. As usual, no announcement of the FOMC policy decisions will be made until after its next meeting, now scheduled for Dec. 20.
Minutes of the FOMC's previous meeting, released yesterday, indicate the group was concerned that the forecasts of an imminent end to the recession and a moderate recovery next year might not be realized. As a result, it decided to seek growth of M-2 -- the measure of money that includes currency in circulation, checking deposits, savings deposits, small time deposits, money market mutual fund shares and some other items -- at an 8 1/2 percent to 9 1/2 percent rate between September and December. The same target was set for M-3, a broader monetary aggregate.
As announced earlier by Fed Chairman Paul A. Volcker, the committee agreed largely to disregard changes in M-1, which includes only currency and checking account deposits, because it would likely be inflated by deposits of money from maturing All-Savers certificates.
But the FOMC also agreed that the system should try to hit its short-term target for M-2 and M-3 while "taking account of the desirability of somewhat reduced pressures in private credit markets in the light of current economic conditions. Somewhat slower growth, bringing those aggregates around the upper part of the ranges set for the year ending this quarter , would be acceptable and desirable in a context of declining interest rates."
Then the minutes add, "Should economic and financial uncertainties lead to exceptional liquidity demands, somewhat more rapid growth in the broader aggregates would be tolerated."
Despite the deliberately vague wording, the October meeting minutes seem to indicate the FOMC will not try to bring growth of the aggregates, which are well above the upper limits of their target ranges, back within bounds if it would take higher interest rates to do the job.
Moreover, if depositors keep putting large amounts of money into easily accessible checking accounts as a precaution against some new economic or financial difficulty, and that boosts growth of the aggregates, that, too, will be okay.
Three of the 12 members of the FOMC voted against the October directive, with all three wanting a somewhat tighter policy. Robert Black, president of the Federal Reserve Bank of Richmond, for example, "preferred to direct operations in the period immediately ahead toward restraining monetary growth." Black was worried that with M-1 growth already strong, lower interest rates might cause it to speed up even more and force the Fed at some later point to turn to a restrictive policy to slow it down, the minutes indicated.
Yesterday's drop in the discount rate suggests the FOMC decided this week on a continuation of the policy course it laid out in October, with the emphasis on providing financial markets with enough liquidity at least to keep interest rates from rising and perhaps moving downward.