By Neil Irwin
Washington Post Staff Writer
Friday, January 11, 2008
Federal Reserve Chairman Ben S. Bernanke yesterday signaled that the central bank will cut interest rates aggressively to try to prevent a serious economic downturn, using unusually direct and forceful language.
In the past two weeks, new evidence has emerged that the United States is at risk of entering a recession. Just yesterday the nation's largest retail chains reported weak December sales, and credit card companies American Express and Capital One said they are seeing more unpaid bills.
In a speech in Washington, Bernanke said fed policymakers "must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability."
Bernanke, in his first public comments of 2008, said that "additional policy easing may well be necessary."
That probably means the central bank will cut the short-term interest rate it controls by half a percentage point at its meeting at the end of the month, economists said. Such a move would stimulate the economy by making it cheaper for consumers and businesses to borrow money. At both of its previous two meetings, the Fed's policymaking committee cut the federal funds rate by a quarter percentage point. It is now 4.25 percent.
There is a 92 percent chance the Fed will cut that rate by half a percentage point, based on futures market pricing yesterday. That figure was 76 percent before Bernanke's speech.
"The backdrop here is the Fed is worried that the economy could be sliding into a recession," said Bruce C. Kasman, chief economist at J.P. Morgan Chase. He said the central bank is likely to cut rates at each of its next two meetings and "decided it was desirable and important to signal that to the market clearly."
At its two most recent meetings, the Fed's policymaking committee has indicated it considers inflation to be a major worry. Oil and other energy prices have been rising, and a weaker dollar could make imports more expensive. Rate cuts tend to result in a weaker dollar, a potential source of inflation.
But yesterday, Bernanke played down those worries, noting that higher unemployment tends to reduce inflationary pressure. "Thus far, inflation expectations appear to have remained reasonably well anchored, and pressures on resource utilization have diminished a bit," he said to Women in Housing and Finance and the Exchequer Club.
"It looks like the focus of the Federal Reserve has moved away from inflation and toward growth," said Drew Matus, a senior economist at Lehman Brothers.
After the speech, Bernanke was asked whether he expects, as the questioner put it, "the r-word."
"The Federal Reserve is not currently forecasting a recession," Bernanke said. "We are forecasting slow growth. But as I mentioned today, there are downside risks and therefore it's very important for us to stand ready . . . to take substantive action to address those risks and provide some insurance against those negative outcomes."
The risks the economy faces were underscored yesterday by reports that suggest American consumers are pulling back. Major U.S. retail chains' sales grew 2.2 percent this holiday season, according to an industry group, less than the rate of inflation and representing the weakest holiday season since 2002.
American Express took a $440 million charge because more holders of its credit cards failed to pay their debts. Its chief executive said that the poor credit trends were most pronounced in California, Florida, and other states with big losses from the housing downturn. Capital One of McLean warned investors that its profit for 2007 would be sharply lower than forecast for the same reason.
As Bernanke indicated that he is willing to use monetary policy to combat the risk of a serious downturn, momentum continued to gather for using the government's other major economic policy tool -- fiscal stimulus -- to combat the slump in the economy.
President Bush has said he may propose government action to stimulate the economy -- probably a tax cut. Congressional Democrats are formulating stimulus measures of their own. Yesterday, former Treasury secretary Robert Rubin, former Fed vice chairman Alice Rivlin and other leading economic thinkers joined the chorus advocating such a move.
"You can care very deeply about the structural fiscal condition and still believe that properly structured stimulus makes sense," said Rubin, who was leading a Brookings Institution panel on how a stimulus should be designed.
Brookings scholars Douglas W. Elmendorf and Jason Furman recommended that a stimulus plan be implemented quickly if it is to have any hope of averting an economic downturn, that it be targeted to put money in the pockets of people who are most likely to spend it and that it be a one-time shot so as not to increase long-term deficits.
Panelists, including Republican economist Martin Feldstein, generally agreed on that approach, though they did not express great confidence that legislation could make it through Congress and the White House with those goals intact.
Bernanke told his audience that his views on a stimulus package were "inchoate" when asked about it. He said he is interested in discussing specific plans with the administration and congressional leaders as they develop them.
The speech was a homecoming of sorts for Bernanke; it was delivered in the Mayflower Hotel, where, in 1965, Bernanke was eliminated from the National Spelling Bee for misspelling "edelweiss."