Since September 2007, the Federal Reserve has lowered the Fed Funds Rate by 1.000%. This has caused Prime Rate to fall by 1.000%, too. This is because the Fed Funds Rate and Prime Rate are directly related.
In mathematical terms, the relationship looks like this:
(Prime Rate) = (Fed Funds Rate) + (3.000%)
So, because Prime Rate is the interest rate upon which credit card rates are based, as the Fed Funds Rate falls, so does the cost of consumer debt.
This is how rate-cuts spur the economy.
When the Federal Reserve lowers the Fed Funds Rate, Americans spend less money on interest payments. Therefore, there is more money available for savings and/or spending on other goods and services.
Considering that Americans carry $2.5 trillion of non-mortgage consumer debt, the Federal Reserve's cumulative 1.000% rate cut is now saving Americans $25 billion dollars on an annual basis.
In the face of weak economic data, the Federal Reserve is expected to cut the FFR again this month to jump-start the economy. Every additional quarter-percent cut would save Americans $520 million in interest payments monthly.
Source
How the failure of subprime mortgages hurts the overall economy
John Gallagher
Detroit Free Press, January 6, 2008
http://www.freep.com/apps/pbcs.dll/article?AID=/20080106/BUSINESS06/801060585/1002/BUSINESS
(Image Courtesy: Wall Street Journal Online)
