The Federal Reserve Board yesterday cut its discount rate from 9 percent to 8 1/2 percent in an effort to keep the current pause in the nation's economic expansion from turning into a recession.
The cut in the discount rate -- the interest rate financial institutions pay when they borrow money directly from Federal Reserve banks -- should ensure some further decline in short-term interest rates, which have already tumbled more than two full percentage points since the first of September.
As evidence of the economic slowdown has mounted, the Federal Reserve has responded by providing more reserves to the banking system. That modest easing of monetary policy, plus the impact of slower economic growth on financial markets, has helped push short-term rates lower.
Yesterday's more aggressive action, taken by a unanimous vote of the seven Federal Reserve governors, gave money markets a powerful signal that the Fed nevertheless wants to see interest rates lower still, analysts said.
For one thing, major commercial banks are now likely to reduce their prime lending rate from the current level of 11 3/4 percent. The banks' cost of obtaining funds to loan has been falling, but banks have been slow to cut the prime rate, to which many business and some consumer loans are tied, in order to boost their profits.
Treasury Secretary Donald T. Regan and a number of financial analysts for some time have been urging the Fed to move more boldly to boost growth of the money supply and keep the current pause in the economic expansion from turning into another recession.
The most closely watched measure of money, M1, has shown little growth since June. At the same time, the extremely rapid expansion of the economy in the first half of the year has all but disappeared, with the gross national product rising at only a 1.9 percent annual rate in the third quarter after adjustment for inflation.
Moreover, Commerce Secretary Malcolm Baldrige, commenting yesterday on a report that new orders received by American manufacturers of durable goods such as autos and machinery fell 4.1 percent in October, said he sees "relatively little" economic growth this quarter.
Meanwhile, the Labor Department said that consumer prices rose a seasonally adjusted 0.4 percent last month, the same increase as in September and in line with the 4.2 percent increase in such prices in the past year.
In its announcement of the discount rate cut, the Federal Reserve said the step was "taken against the background of growth in M1 and M2 in the lower part of the desired ranges and in the context of distinct moderation in the pace of the economic expansion, of relative stability in producer and commodity prices in recent months, of the restrained trend of wages and costs, and of the continued strength of the dollar internationally."
M1 is a measure of money that includes currency and travelers checks in circulation and checking deposits at financial institutions. M2, a broader measure, includes M1 plus savings and small time deposits, most money market mutual fund shares and some other items.
Early this year, the Fed set a target for M1 growth of 4 percent to 8 percent between the fourth quarter of last year and the current quarter. Currently, the level of M1 is only slightly above the lower boundary of that target, though some analysts believe its growth is picking up this month. M2 similarly is in the lower part of its 6 percent to 9 percent target range.
"It's likely the Fed has come around to the conclusion that despite the substantial decline in interest rates they may still be too high to allow a sustained economic expansion," said economist David M. Jones of Aubrey G. Lanston & Co., a New York government securities dealer.
Philip Braverman, economist at Briggs Schaedle & Co., said even the discount rate cut and recent moves to supply large amounts to reserves to the banking system might not be enough. "The rapidity of the latest easing initiatives suggest a new Fed anxiety to produce results," he said. "And that suggests the potential for still more easing to come."
Long-term rates, which are regarded by most economists as more important economically than short-term rates, have fallen much less in the last two months. AAA corporate bond rates, for example, have dropped from slightly more than 13 1/2 percent at the end of June to about 12 1/2 percent now.
Many analysts think the prospect of continued large federal budget deficits are helping keep long-term rates high, and particularly high relative to inflation. With only a very limited likelihood that the Reagan administration and Congress can agree on a deficit reduction plan in 1985, financial analysts think long-term rates will stay high.
"The outlook for bond yields depends more on Congress than on the short-term path of the economy," economists Roger Brinner and David Wyss of Data Resources Inc. said.