Federal Reserve officials left their target for overnight interest rates unchanged yesterday but signaled that they are ready to cut rates if a war with Iraq destabilizes world financial markets.
The Federal Open Market Committee, the central bank's top policymaking group, reiterated its belief that the economy's recent lackluster performance is primarily due to uncertainties created by the prospect of war, including the sharp increase in world oil prices. As those uncertainties are resolved, low interest rates and continuing productivity growth "will provide support to economic activity sufficient to engender an improving economic climate over time," a committee statement said.
In other words, Fed Chairman Alan Greenspan and his colleagues do not think the economy will need another push from further interest rate cuts unless there is a serious adverse reaction to the war in financial markets. The target is already at 1.25 percent, the lowest in more than 40 years. If necessary, the Fed could act before the next policymaking session, May 6.
The Federal Reserve "still stands ready to act if things go wrong in Iraq," said Ian C. Shepherdson, chief U.S. economist for High Frequency Economics, a private consulting firm in Valhalla, N.Y. "But the clear impression we take from the statement is that the Fed firmly believes, ex-Iraq, that rates are low enough. We agree."
Markets reacted little to the Fed statement. The Dow Jones industrial average rose 0.6 percent, to 8194.23. The Nasdaq composite index was up 0.6 percent at 1400.55, and the Standard and Poor's 500-stock index climbed 0.4 percent, to 866.45. Oil for April delivery fell to $31.67 a barrel on the New York Mercantile Exchange, the lowest since Jan. 8. And the dollar was little changed against the euro but rose to 118.86 Japanese yen to the dollar, a one-month high.
The policymakers met in the Fed's office complex on Constitution Avenue, despite a standoff a short distance away on the other side of the street between law enforcement officials and a North Carolina farmer who had driven a vehicle he said was laden with explosives into a pond on the Mall. A Fed spokeswoman declined for security reasons to say whether the session took place in the Fed's boardroom, whose windows face Constitution Avenue, or elsewhere in the complex.
The committee said after the meeting that the economy is so fraught with uncertainty that it decided not to issue a statement about the balance of risks between economic weakness and inflation. Normally the Fed officials conclude that one risk outweighs the other, or that they are balanced.
"In light of the unusually large uncertainties clouding the geopolitical situation in the short run and their apparent effects on economic decision making, the committee does not believe it can usefully characterize the current balance of risks . . . until some of those uncertainties abate," the statement said. "In the current circumstances, heightened surveillance is particularly informative."
The phrase "heightened surveillance" means the Fed will scrutinize the behavior of financial markets, and it implies that if there are signs of serious trouble -- such as that occurred in some markets in 1998 after the Russian government defaulted on part of its debt -- the Fed would respond by cutting rates and pumping a large amount of cash into the banking system.
Some analysts have worried that with the Fed's target so low, the central bank does not have room to cut rates enough to offset a huge shock to the economy or financial markets. But Greenspan and several other Fed officials have said they would have plenty of "ammunition" with which to bolster the economy even if the target were lowered to zero.
They have argued that if the overnight rate went to zero, the Fed could target a longer-term rate, such as the yield on two- or five-year Treasury notes. Since the Fed has an unlimited amount of money, it could purchase as many securities as it needs to supply the desired amount of cash to the banking system, and through it, to the economy.
In addition, as the Fed did after the Sept. 11, 2001, terrorist attacks, it could reduce the interest rate it charges on loans made directly by a regional Fed bank to financial institutions and actively encourage them to borrow. Tens of billions of dollars entered the economy through those so-called discount window loans.
In its brief assessment of the current state of the economy, the committee said: "While incoming economic data since the January meeting have been mixed, recent labor market indicators have proven disappointing. However, the hesitancy of the economic expansion appears to owe importantly to oil price premiums and other aspects of geopolitical uncertainties."
Many forecasters had expected economic growth to pick up early this year after registering only a 1.4 percent annual rate in the final three months of last year. But the economists generally have lowered their predictions as a result of reports such as one that showed the number of payroll jobs fell more than 300,000 last month.