A Rate of Zero Percent From the Fed? Some Analysts Say It Could Be Coming

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Zero percent interest rates! It sounds like free money, or maybe a promotional deal from General Motors to get people to buy Hummers. Are zero rates coming to the Federal Reserve?

As it happens, the Fed is surprisingly close to that point already. On Wednesday, the central bank lowered its target for the federal funds rate — the rate that banks charge each other on overnight loans — to 1 percent from 1.5 percent.

But in practice, the actual federal funds rate fluctuates slightly around its target as the Fed carries out its open-market operations in the money markets. And because banks and financial institutions have been so frightened about lending in the last month, the actual Fed funds rate has been below 1 percent for the last two weeks. On Tuesday, it averaged only 0.67 percent.

A growing number of analysts now predict that the economy is so weak that the Fed will have to reduce its official target to zero if it wants to jumpstart the stalled economy.

Japan’s central bank reduced its benchmark interest rate to zero for five years, from 2001 to 2006. It did so mainly to combat a particularly persistent case of deflation, a broad-based decline in consumer prices, and to revive economic growth.

Some analysts see signs that the United States faces a similar threat. Like Japan’s, American banks have become so decimated by losses in real estate that they are either unable or unwilling to resume normal lending. And as prices for oil and many other commodities have crashed during the past two weeks, some analysts now warn that deflation might be a threat here as well.

With the Fed funds rate already down to 1 percent, and below one percent on many days, the central bank is fast approaching what economists call the “zero bound.”

If the Fed funds rate did drop to zero, it would not mean free money for consumers or businesses. The zero rate would only apply to the reserves that banks are required to maintain and that they lend to one another. Customers would still have to pay some interest, but the rates could be extremely low for some business borrowers.

The real question for policy makers is what to do if they reach a zero rate and still want to rev up the economy. Fed officials have studied the question closely, and the Fed chairman, Ben S. Bernanke, gave a famous speech on the issue when he was a Fed governor in 2002.

In that speech, Mr. Bernanke described a series of options. The simplest option would be for the Fed to start buying Treasury securities with longer maturities. Buying up those longer-term securities would push up their prices and drive down longer-term interest rates. If that didn’t work, the Fed could start buying up privately-issued debt, like corporate bonds.

In effect, the Federal Reserve would be printing more money and injecting it into the economy — a strategy of “quantitative easing,” in Fed jargon.

Too much money would provoke a new round of inflation and perhaps yet another asset bubble. But Japanese inflation never took off. After five years, the Bank of Japan cautiously raised its benchmark rate to .5 percent.