By Neil Irwin
Washington Post Staff Writer
Wednesday, September 17, 2008
The Federal Reserve yesterday elected to leave the interest rate it controls unchanged, rebuffing calls to bolster the economy at a time of global turmoil in financial markets.
The central bank's policymaking committee, in a meeting scheduled long before the convulsions that are reshaping Wall Street, decided that it would leave the federal funds rate unchanged at 2 percent. That rate ultimately affects what consumers pay to borrow money through a credit card or pay for an adjustable-rate mortgage, and what businesses must pay to borrow money to expand.
Many on Wall Street were urging the Fed to cut that rate following the bankruptcy of Lehman Brothers, the acquisition of Merrill Lynch, and the turbulence at insurance firm AIG. But Fed leaders were trying to draw a clear line between their efforts to address problems in the financial markets -- such as injecting $70 billion in cash into the banking system yesterday -- and their broad policy to deal with the nation's economic distress. The Fed concluded that it was impossible to know whether, or how much, the volatile times on Wall Street would slow the economy on Main Street.
"They want to see if this is just a temporary blip in the financial turmoil or whether it lasts for a while," said David Wyss, chief economist at Standard & Poor's. "For them to cut rates, it would take some evidence this is hurting the economy, not just the financial markets."
Indeed, the policymaking Federal Open Market Committee didn't seem tremendously concerned about the turbulence in the financial world. "Strains in financial markets have increased significantly," it said in its announcement of the action, which in the view of many analysts was an understatement.
"It does read a little bit like it was written last week," said Michael J. Feroli, a U.S. economist at J.P. Morgan Chase. "It could sound like having a bit of a tin ear to what's going on in the markets."
The central bank also seemed to indicate that risks of higher inflation and weaker-than-expected growth are roughly balanced, indicating that they "are both of significant concern to the Committee" and that it will "act as needed" to promote sustainable growth and low inflation. Many market watchers had expected a clearer signal that the Fed would consider cutting interest rates in the future if the economy gets much worse.
The Fed was meeting under different circumstances than it has for most of the year: Prices for oil and other commodities have fallen sharply in the past three months, and other world economies are slowing, suggesting that upward pressure on energy and other resources may continue to ease. The policymaking committee said in its statement that it "expects inflation to moderate later this year and next year."
One sign of the easing of inflation concerns: For the first time in a year, the committee was unanimous, as members who had previously dissented in favor of being more vigilant about inflation went with the crowd.
But the committee didn't express great confidence in the prediction that inflation will moderate, saying the outlook "remains highly uncertain."
Federal Reserve Chairman Ben S. Bernanke has designed his response to the financial crisis in part by relying on his knowledge of the Great Depression, of which he was a leading scholar. By allowing a cascading series of failures in the financial sector and not cutting interest rates, Bernanke concluded in his academic research, the Fed allowed a "financial accelerator" to take hold in which a weak financial sector and weak economy fed back into each other, creating a vicious cycle.
By cutting interest rates to 2 percent in the spring, from 5.25 percent in 2007, Bernanke was aiming to avert a similar phenomenon. Now, with the crisis deepening, the open question is whether that will be enough.
On one hand, the economy has weakened significantly in the past six months, but roughly along the lines that Bernanke and his Fed colleagues had forecast when slashing the rate.
On the other hand, banks and other financial institutions, walloped by the troubles on Wall Street, have tightened their lending standards and charged higher rates for loans. For example, despite the aggressive Fed rate cuts, mortgage rates are still about where they were a year ago. In that sense, the Fed rate cuts have merely prevented the rates that many consumers pay from rising, not lowered the cost of borrowing money in many cases.
In the past few days, the crisis in the financial system has made it hard for the Fed to maintain the rate near its 2 percent target; the central bank buys and sells government bonds to try to maintain the rate, and it has had to make a series of massive cash injections, including the $70 billion yesterday, to keep cash-hoarding banks from bidding up the rate.
"It purely reflects a lack of confidence," said Diane Swonk, chief economist at Mesirow Financial. "No one's willing to lend at 2 percent right now, so it takes these large interventions to get the rate to that point."