The Federal Reserve Board yesterday lowered its discount rate from 7.5 percent to 7 percent, in a move coordinated with similar reductions by the central banks of other major industrial nations.
The central bank of Japan announced it was cutting its discount rate from 4.5 percent to 4 percent just hours before the Federal Reserve announced its action yesterday. West Germany's central bank cut its discount rate from 4 percent to 3.5 percent Thursday.
Major U.S. banks immediately dropped their prime interest rates -- which serves as a base rate for many other loans -- from 9.5 percent to 9 percent. Home mortgage and other personal loan rates are also expected to drop.
The discount rate is the interest rate central banks, including the Federal Reserve, charge their member banks for loans.
The dramatic reduction in interest rates was hailed by Federal Reserve Board Vice Chairman Preston Martin as an "unprecedented" example of international economic cooperation. The action was widely viewed as a joint effort by the major industrial nations to stimulate global economic growth, now that the sharp drop in oil prices has averted fears of inflationary pressure for the foreseeable future.
The decline in interest rates was expected to be a help for many Third World countries that have large loans keyed to international interest rates. The development reportedly cheered Mexican negotiators in Washington yesterday for private sessions with Treasury and other officials working on a new loan aid package.
"We have had the happy coincidence of [international] needs here between and among the three major countries [United States, Japan and West Germany] and other major countries, and domestic considerations all coming together. And that's why it's so unprecedented," Martin said yesterday.
A senior Reagan administration official said the coordinated reduction in interest rates was a direct outgrowth of the international consultation process set in motion by Treasury Secretary James A. Baker III.
"Coordination breeds co-coordination," the administration official said, referring also to a meeting in New York last Sept. 22 of the world's five leading industrial nations -- the United States, Japan, West Germany, Britain and France -- which is commonly referred to in international monetary circles as the Group of Five. At that meeting, the five nations agreed to a joint intervention effort to push down the exchange rate of the dollar. "As the G-5 learns it can have confidence in itself, and can work together honorably, it will take other marginal steps forward," the official said.
Representatives of the five nations met again in London last January and reached an understanding that the central bankers of the five countries would determine a precise timetable for orchestrating the reductions in their respective discount rates.
"I honestly don't think it could have happened this way without the coordinated effort [of the five nations]," Martin agreed. "I think we and the Japanese would have moved [rates lower] at some time, maybe not at the same time, and I don't know whether the Germans would have moved at all.
Last week, with oil prices falling and fears of resurgent inflation all but eradicated, the time was considered ripe for action, administration officials said yesterday, and a schedule established in a series of telephone calls among Federal Reserve Chairman Paul A. Volcker, and his counterparts in Tokyo, Frankfurt and other industrial centers.
In recent weeks, Volcker had expressed caution about pushing interest rates down further, in the fear that it might trigger a free fall in the dollar, thus setting off a new round of inflation.
But in its statement yesterday announcing a unanimous 6-to-0 vote for lowering the discount rate (Governor Martha Seger was absent), the Federal Reserve said that "prospects for sustaining improved price performance and continued restraint on costs have been further enhanced by the recent sharp declines in oil prices, and the economic expansion appears to be proceeding within the nation's growth potential."
At the meetings of the five nations in New York and London, Baker had urged the other countries, especially Japan and West Germany, to lower interest rates to pave the way for the Federal Reserve to lower its discount rate. Japan, anxious to stimulate a sluggish economy, and to cooperate in the effort to deflate the dollar, was willing to move ahead.
But the West German government balked, administration officials said, arguing that its interest rates were low enough, and that cutting them further might create inflationary problems in West Germany.
At the London meeting, U.S. officials said, Volcker wasn't especially anxious to force the issue, not only in fear of putting extra pressure on the dollar, but also because economic indicators in December suggested that U.S. economic activity might be resurging. When the London session adjourned, an administration official said yesterday, all agreed that the proposed interest rate action wouldn't be taken if signs of inflation reappeared. But since then, economic indicators have looked softer.
The slide in oil prices, which helped lower worries about market interest rates and inflation, finally persuaded the West German government that a reduction in interest rates was a reasonable step, especially in light of high unemployment rates in that country. Moreover, the West German inflation rate was down to 0.7 percent.
When the West German central bank yielded on Thursday and cut its discount rate, it opened the floodgates: the Dutch and the French followed immediately, joined by the Japanese and then the Federal Reserve yesterday.
Long-term interest rates have fallen precipitously in the last two weeks to their lowest levels in eight years and mortgage rates in some areas already have dipped below 10 percent. The lower rates are giving businesses and mortgage holders the opportunity to refinance their loans at more favorable terms.