Wednesday, January 7, 2009; Page D03
The economy is set to remain weak well into this year, and could even be at risk of entering a "prolonged contraction," leaders of the Federal Reserve concluded last month, as they agreed to take aggressive new steps to contain the recession.
The central bank's policymaking committee was grappling at its Dec. 16 meeting with an abrupt deterioration of the economy, and even the risk of a dangerous cycle of falling prices, according to minutes released yesterday. Those minutes shed light on the committee's decision to take unprecedented steps, including cutting the interest rate the Fed controls effectively to zero; technically, the committee set a target range for the federal funds rate between zero and 0.25 percent.
According to the minutes, the officials expect that the sharp contraction in the U.S. economy in the fourth quarter will be followed by continued contraction in the first half of 2009, after which a slow recovery would begin. Some also believe that the severe financial crisis, the drop in Americans' wealth, and the global nature of the slowdown create the "distinct possibility" of ongoing economic difficulties.
Officials saw a significant risk of inflation declining and persisting at "uncomfortably low levels" -- meaning levels that risk a deflationary spiral in which prices drop and people curtail spending all the more.
For those reasons, the Fed said it was inclined to keep rates "exceptionally low" for some time and said it may expand special lending programs designed to lower the rates that Americans pay for various loans.
Members of the policymaking panel, the Federal Open Market Committee, agreed that the statement announcing its decision "should indicate that all available tools would be employed to promote the resumption of sustainable economic growth and to preserve price stability."
Specifically, the Fed leaders indicated they may expand a $600 billion program to try to push down mortgage rates. Purchases of mortgage-related securities under that program began this week. They also said they could try to push down other long-term rates by buying long-term Treasury securities.
Brian Bethune, chief U.S. economist at IHS Global Insight, highlighted the scope of the Fed's steps. "Monetary conditions are close to the point of near maximum stimulus," he said in a report. "Now it is a matter of lighting the right sparks to get the economy moving again."
Disagreements during the meeting appeared to be unrelated to the overall strategy the Fed will undertake, but how to carry it out. For example, according to the minutes, some of the policymakers preferred to continue setting an explicit numerical target for the federal funds rate, a bank lending rate. They feared that simply setting a range would signal that the Fed had lost control over that rate.
The majority of the committee, on the other hand, felt that setting a range would actually help give banks flexibility.
Even as they agreed that they are likely to hold interest rates low for some time and maintain novel programs to stimulate lending, Fed officials "recognized that, as economic activity recovered and financial conditions normalized, the use of certain policy tools would need to be scaled back, the size of the balance sheet and level of excess reserves would need to be reduced, and the committee's policy framework would return to focus on the level of the federal funds rate." In other words, the unconventional policy tools could last only as long as the economic and financial crises do.
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