According to the New York Times, it appears that the Federal Reserve is close to lowering the federal funds rate - the rate the banks charge each other on overnight loans - to 1 percent; down from 1.5%.

The fed funds rate actually fluctuates a little bit, and because banks and financial institutions are afraid about lending, the fed funds rate has actually been below 1%, averaging only .67 percent over the last two weeks.

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 jump start the stalled economy.

Believe it or not, Japan’s central bank reduced its benchmark interest rate to zero for five years, from 2001 to 2006 in a move to avoid deflating, a decline in consumer prices and to help revive it’s economy.

The losses in real estate due to sub-prime mortgage and foreclosure problems, have many banks unable or unwilling to resume lending. And as the price of oil and other commodities plummet, some are now warning of a deflation threat. This may trigger the fed to lower the fed funds rate even lower - to an unprecedented 9%.

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.

But what happens if the rate is reset to 0% and it doesn’t help the economy? Well, Fed chairman, Ben Bernanke gave a famous speech on this very subject when he was a Fed governor back 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.

It looks like the Fed will end up reducing the fed fund rate to 0% and take it’s chances. However, if Barack Obama were to be elected, it may change the psychology of the financial industry and turn things around. We will just have to wait and see.