Federal Reserve Interest Rate Changes: 2001-2008

The Federal Open Market Committee (FOMC) decided at its scheduled meeting held on October 29 to lower the target rate for federal funds to 1% from 1½% set at its unscheduled meeting of October 8, 2008. In making its decision to reduce the target, the FOMC stressed the following factors: (1) the pace of economic growth appears to have slowed markedly owing importantly to a softening of consumer spending; (2) business equipment spending and industrial production have weakened; (3) economic slowdowns abroad have dampened the prospects for U.S. exports; (4) intensified strains in financial markets are also likely to further reduce spending; and (5) inflation prospects have improved due to declines in energy and other commodity prices. The next schedule meeting of the FOMC is set for December 11, 2008.



Order Code 98-856 E
Updated October 29, 2008
Federal Reserve Interest Rate Changes:
2001-2008
Marc Labonte and Gail E. Makinen
Government and Finance Division
Summary
The Federal Open Market Committee (FOMC) decided at its scheduled meeting
held on October 29 to lower the target rate for federal funds to 1% from 1½% set at its
unscheduled meeting of October 8, 2008. In making its decision to reduce the target,
the FOMC stressed the following factors: (1) the pace of economic growth appears to
have slowed markedly owing importantly to a softening of consumer spending; (2)
business equipment spending and industrial production have weakened; (3) economic
slowdowns abroad have dampened the prospects for U.S. exports; (4) intensified strains
in financial markets are also likely to further reduce spending; and (5) inflation prospects
have improved due to declines in energy and other commodity prices. Because of the
international scope of the financial turmoil, the downside risks to growth remain.
Nevertheless, the FOMC believes that the substantial easing of monetary policy to date,
combined with other measures to provide liquidity to the financial system, should help
to promote moderate growth over time. The Board of Governors also reduced the
discount rate for primary credit to 1¼% from 1¾%. The next scheduled meeting of the
FOMC is set for December 11, 2008. This report will be updated as events warrant.
Rates Changes
The Fed directly changes two interest rates. The first, called the discount rate, is an
administered rate explicitly set by the Fed. It is the rate at which the Fed lends short-term
funds to banks, pursuant to P.L. 96-221, the Monetary Control Act of 1980. It is
determined by the seven-person Board of Governors of the Federal Reserve System. The
second, known as the federal funds rate, is a market rate at which banks lend to each other
overnight to meet their “reserve requirements” and other liquidity needs. The Fed sets a
target for this rate and buys and sells U.S. Treasury securities with an aim to achieving
the target, which speedily becomes known to market participants. It is decided by a 12-
person Federal Open Market Committee, which includes each member of the board plus
a varying five-person roster selected from among the 12 regional Federal Reserve Bank
presidents (among the 12, the New York bank is always represented on the FOMC).

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On January 6, 2003, the Board of Governors announced a fundamental change to the
setting of the discount rate. Henceforth, it was to be made a penalty rate for those banks
who chose to borrow from the Federal Reserve to meet temporary reserve deficiencies as
opposed to borrowing in the federal funds market. A primary discount rate of 2¼% was
set for banks judged to be in a sound financial condition, whereas banks whose financial
condition was judged to be riskier would be required to pay a higher secondary rate of
2¾%. This change in operating procedure is shown in Table 1.
Understanding the Announcements
Because the discount rate is administered, changes in it are stated explicitly. Hence,
the changes shown in Table 1 are exact. Because the federal funds rate varies somewhat
in response to market conditions, when the Fed changes only the federal funds rate, it may
specify the target rate, or it may only announce that it is “increasing [or decreasing]
slightly the degree in pressure on reserve positions” and that the action is “expected to be
associated with a small increase [or decrease] in short-term money market interest rates.”
In the latter case, the size of the rate change must be inferred. Hence, some of the federal
funds rates in the table are approximate, based on observation instead of announcements.
Rationale for Changes
The Fed tries to keep the economy operating at an output level consistent with a low
rate of inflation and low unemployment. It therefore seeks a level of interest rates at
which the economy will grow at its potential to produce. The interest rate levels that
produce this growth rate vary with the course of the business cycle. Different rates are
judged appropriate at different times. Changes in interest rates are the most visible signs
of the Fed’s monetary policy, immediately affecting financial institutions and markets of
all kinds here and abroad. Unusual financial market conditions such as those related to the
Asian financial crisis of 1997-1998, the Russian debt crisis of 1998 and the terrorist
attacks of September 2001 also influence Fed decisions on rate changes. The Fed reports
to Congress twice yearly on its monetary policy including rate changes, in oversight
hearings in February and July as originally required by P.L. 95-188, the Federal Reserve
Reform Act.
Monetary policy has varied considerably over the current economic expansion that
began early in 2001. Initially, it was aimed at setting the expansion in motion. To do
this, the federal funds target was reduced from 5½% in March 2001 to 1% in June 2003.
It remained at 1% for a year. As the expansion gathered momentum, the target was
raised in 17 equal increments spread over two years to 5¼%. Even as the FOMC drew
attention to upward movements in the core rate of inflation at various meeting during
2006 and 2007, it continued to express the view that it would moderate over time as
would the rate of growth of GDP. These reasons appear to be important for leaving the
rate unchanged at 5¼% for more than a year. However, during the late summer of 2007,
the fall in housing prices and conditions in financial markets related to the difficulty in
refinancing sub-prime mortgages became a matter of concern. To ease these conditions,
the Board of Governors on August 17, 2007, reduced the discount rate for primary credit
to 5¾%. This was followed on September 18 with another reduction of ½% and a
reduction in the federal funds target to 4¾%. Additional cuts of ¼% in both rates were

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approved on October 31 and December 11, 2007. On January 22 the target was reduced
by ¾% and on January 30 by a further ½%.
The economy began to soften in the third quarter of 2007 (GDP growth was
negative, falling at an annual rate of -0.2%). In the first quarter of 2008 it was positive
again, and rose at an annual rate of 0.9%. During the second quarter, the growth was also
positive and at an annualized rate of 2.8%. The unemployment rate began to rise on a
sustained basis in February and in August it reached 6.1% (it remained at this rate in
September). Job losses since December 2007 are in excess of 700,000. As conditions
in financial markets worsened and the economy softened, the FOMC and the Board
approved further reduction in the federal funds target and discount rate. Both rates were
lowered on March 18, April 30, October 8, and October 29 and the discount rate was
reduced itself on March 16. They now stand at 1% and 1¼%, respectively. As these
developments were taking place, the world price of energy began to rise at a brisk rate.
Rising energy prices threatened to boost the overall rate of inflation posing a challenge
to the Fed’s mandated commitment to stable prices. Initially, the Fed reacted by holding
the federal funds target steady. However, as the magnitude and international scope of the
credit crisis became apparent and energy and other commodity prices began to fall, the
target was lowered and the Fed undertook a number of new and innovative measures to
shore up the financial system. These measures were also undertaken to shore up the
economy in general as growth slowed and job losses mounted.
For further discussion, see CRS Report RL30354, Monetary Policy and the Federal
Reserve: Current Policy and Conditions, by Marc Labonte and Gail Makinen.

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Table 1. Recent Interest Rate Changes
Federal Funds Rate Target
Discount Rate
Date
Before
Change
After
Before
Change
After
Apr. 18, 2001
5




4
May 15, 2001


4
4


June 27, 2001
4





Aug. 21, 2001





3
Sept. 17, 2001


3
3


Oct. 2, 2001
3




2
Nov. 6, 2001


2
2


Dec. 11, 2001
2





Nov. 6, 2002





¾
Jan. 6, 2003



2¼a


June 25, 2003


1


2
June 30, 2004
1

1 ¼
2


Aug. 10, 2004


1 ½



Sept. 21, 2004


1 ¾



Nov. 10, 2004


2


3
Dec. 14, 2004
2


3


Feb. 2, 2005






Mar. 22, 2005






May 3, 2005


3


4
June 30, 2005
3


4

4
Aug. 9, 2005






Sept. 20, 2005






Nov. 1, 2005


4


5
Dec. 11, 2005
4


5


Jan. 31, 2006






Mar. 28, 2006






May 10, 2006


5


6
June 29, 2006
5


6


Aug. 17,2007






Sept. 18, 2007






Oct. 31, 2007





5
Dec. 11, 2007



5


Jan. 22, 2008





4
Jan. 30, 2008


3
4


Mar. 18, 2008
3


3¼b


Apr. 30, 2008


2



Oct. 8, 2008
2

1 ½



Oct. 29, 2008
1 ½

1



Source: Federal Reserve System.
a. As of January 6, 2003, 2¼% was the new primary rate and 2¾% was the secondary rate.
b. On March 16, 2008, the Board reduced the rate by ¼% to 3¼%.