Policymakers Indicate They Will Keep Prodding Economy Until It Rebounds
By John M. Berry
Washington Post Staff Writer
Thursday, June 26, 2003; Page A01
Federal Reserve officials, concerned that the U.S. economy is not growing fast enough to reduce unemployment and eliminate the possibility of deflation, yesterday cut their target for overnight interest rates by a quarter of a percentage point, to 1 percent.
The Fed officials' action and their accompanying statement underscored their intention to keep stimulating the economy until it fully regains its footing, a message that analysts said could provide an important psychological boost to wary investors and business executives.
In particular, Fed officials signaled that they will not begin raising rates until all possibility of deflation vanishes.
There are signs the weak economy is stabilizing but is not yet growing at a healthy pace, the Fed said in a statement issued by its policymaking Federal Open Market Committee. The group judged that a small rate cut "would add further support for an economy which it expects to improve over time."
Fed officials have cut rates 13 times since January 2001, when their target for overnight rates was 6.5 percent and the nation was about to drop into a recession. Since then, many interest rates -- such as those for mortgages, car loans and highly rated corporate notes -- have fallen to near their lowest levels in four decades.
Low rates, combined with large tax cuts, have helped moderate the economy's downturn by fueling increased consumer spending. But the economy has failed to return to a robust pace of growth and continues to shed jobs. The unemployment rate reached 6.1 percent last month, the highest level in almost nine years.
The economy remains sluggish partly because businesses remain reluctant to invest in new plants and equipment. While lower interest rates may not spur much more consumer spending, analysts hope the Fed's aggressive stance will encourage investors and businesses to borrow and spend money.
As the rate target has fallen, some economists and analysts have worried that the Fed could run out of interest rate ammunition with which to stimulate the economy.
A number of officials, including Fed Chairman Alan Greenspan, have argued that if overnight rates fell to zero, the central bank could use other techniques to pump money into the economy. But it is hard to predict how smoothly money markets would function under such circumstances, and officials have stressed that they want to avoid having to find out.
Neither stock nor bond markets reacted positively to the Fed decision, in part because some investors and analysts had expected a cut of half a percentage point rather than a quarter-point. The Dow Jones industrial average closed down 98.32 points, or 1.1 percent, at 9011.53. The Standard & Poor's 500-stock index fell 8.13 points, or 0.8 percent, to 975.32, and the Nasdaq composite index dipped 2.95 points, or 0.2 percent, to 1602.66. Bond prices also dropped, and their yields rose.
The odds of growth picking up and it stalling are "roughly equal," the committee said. On the other hand, the risk "of an unwelcome substantial fall in inflation exceeds that of a pickup in inflation from its already low level," the statement said, indicating that the officials continue to worry about deflation -- a broad decline in the overall level of consumer prices.
Furthermore, the committee added, the concern about deflation is likely to exceed any worry about rising inflation "for the foreseeable future."
Officials consider the probability very low that deflation will occur, but the damage that might result from such an episode could be severe, they have said.
The danger is that when the overall level of prices is falling, firms might have to cut wages, borrowers would find debts harder to repay and the values of assets such as stocks and houses could fall. The results could be economically devastating.
The committee's language about the possibility of deflation signaled two things, analysts said.
First, Fed officials will cut rates again if growth does not improve significantly. Indeed, Robert T. Parry, president of the San Francisco Federal Reserve Bank, dissented from the 11-member committee majority in the vote to cut by a quarter-point. Parry favored a half-point cut. Often in the past, when one member has dissented there were others who also would have preferred a different outcome but not strongly enough to register a formal dissent.
Second, Fed officials intend to keep their rate target low for an extended period even if economic growth accelerates strongly in coming months.
"The dissent by President Parry is notable and possibly a hint that the hurdles for another cut are not very high," said economist Robert V. DiClemente of Citigroup Inc. in New York.
Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd. in Valhalla, N.Y., said the statement indicates the officials think that "things are getting better, slowly" and that "the Fed is ready to ease again if the data don't improve further in the near term. They won't be hiking [rates] anytime soon."
Shepherdson and many other economists have been predicting that growth will pick up strongly in the second half of the year, perhaps with the pace of growth doubling from its annual rate of 2 percent or so in the first half.
Greenspan and other Fed officials have said such forecasts are reasonable. But the committee statement indicated that they do not regard it as a sure thing: "Recent signs point to a firming in spending, markedly improved financial conditions, and labor and product markets that are stabilizing. The economy, nonetheless, has yet to exhibit sustainable growth."
Recent signs of the economy's health remain mixed, including three reports yesterday. Sales of new homes soared last month to a record annual rate of 1.157 million, the Commerce Department said. And home resales rose slightly to an annual rate of 5.92 million, not far below the record 6.10 million rate set in January, according to the National Association of Realtors.
In contrast, new orders for durable goods, such as computers, trucks, machinery and defense equipment, fell 0.3 percent last month, after a 2.4 percent drop in April, the Commerce Department reported.
In addition to the reduction in the Fed's overnight rate target, the Fed Board cut the central bank's discount rate to 2 percent from 2.25 percent. The discount rate is the interest rate regional Fed banks charge on loans made to financial institutions.
By John M. Berry
Washington Post Staff Writer
Thursday, June 26, 2003; Page A01
Federal Reserve officials, concerned that the U.S. economy is not growing fast enough to reduce unemployment and eliminate the possibility of deflation, yesterday cut their target for overnight interest rates by a quarter of a percentage point, to 1 percent.
The Fed officials' action and their accompanying statement underscored their intention to keep stimulating the economy until it fully regains its footing, a message that analysts said could provide an important psychological boost to wary investors and business executives.
In particular, Fed officials signaled that they will not begin raising rates until all possibility of deflation vanishes.
There are signs the weak economy is stabilizing but is not yet growing at a healthy pace, the Fed said in a statement issued by its policymaking Federal Open Market Committee. The group judged that a small rate cut "would add further support for an economy which it expects to improve over time."
Fed officials have cut rates 13 times since January 2001, when their target for overnight rates was 6.5 percent and the nation was about to drop into a recession. Since then, many interest rates -- such as those for mortgages, car loans and highly rated corporate notes -- have fallen to near their lowest levels in four decades.
Low rates, combined with large tax cuts, have helped moderate the economy's downturn by fueling increased consumer spending. But the economy has failed to return to a robust pace of growth and continues to shed jobs. The unemployment rate reached 6.1 percent last month, the highest level in almost nine years.
The economy remains sluggish partly because businesses remain reluctant to invest in new plants and equipment. While lower interest rates may not spur much more consumer spending, analysts hope the Fed's aggressive stance will encourage investors and businesses to borrow and spend money.
As the rate target has fallen, some economists and analysts have worried that the Fed could run out of interest rate ammunition with which to stimulate the economy.
A number of officials, including Fed Chairman Alan Greenspan, have argued that if overnight rates fell to zero, the central bank could use other techniques to pump money into the economy. But it is hard to predict how smoothly money markets would function under such circumstances, and officials have stressed that they want to avoid having to find out.
Neither stock nor bond markets reacted positively to the Fed decision, in part because some investors and analysts had expected a cut of half a percentage point rather than a quarter-point. The Dow Jones industrial average closed down 98.32 points, or 1.1 percent, at 9011.53. The Standard & Poor's 500-stock index fell 8.13 points, or 0.8 percent, to 975.32, and the Nasdaq composite index dipped 2.95 points, or 0.2 percent, to 1602.66. Bond prices also dropped, and their yields rose.
The odds of growth picking up and it stalling are "roughly equal," the committee said. On the other hand, the risk "of an unwelcome substantial fall in inflation exceeds that of a pickup in inflation from its already low level," the statement said, indicating that the officials continue to worry about deflation -- a broad decline in the overall level of consumer prices.
Furthermore, the committee added, the concern about deflation is likely to exceed any worry about rising inflation "for the foreseeable future."
Officials consider the probability very low that deflation will occur, but the damage that might result from such an episode could be severe, they have said.
The danger is that when the overall level of prices is falling, firms might have to cut wages, borrowers would find debts harder to repay and the values of assets such as stocks and houses could fall. The results could be economically devastating.
The committee's language about the possibility of deflation signaled two things, analysts said.
First, Fed officials will cut rates again if growth does not improve significantly. Indeed, Robert T. Parry, president of the San Francisco Federal Reserve Bank, dissented from the 11-member committee majority in the vote to cut by a quarter-point. Parry favored a half-point cut. Often in the past, when one member has dissented there were others who also would have preferred a different outcome but not strongly enough to register a formal dissent.
Second, Fed officials intend to keep their rate target low for an extended period even if economic growth accelerates strongly in coming months.
"The dissent by President Parry is notable and possibly a hint that the hurdles for another cut are not very high," said economist Robert V. DiClemente of Citigroup Inc. in New York.
Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd. in Valhalla, N.Y., said the statement indicates the officials think that "things are getting better, slowly" and that "the Fed is ready to ease again if the data don't improve further in the near term. They won't be hiking [rates] anytime soon."
Shepherdson and many other economists have been predicting that growth will pick up strongly in the second half of the year, perhaps with the pace of growth doubling from its annual rate of 2 percent or so in the first half.
Greenspan and other Fed officials have said such forecasts are reasonable. But the committee statement indicated that they do not regard it as a sure thing: "Recent signs point to a firming in spending, markedly improved financial conditions, and labor and product markets that are stabilizing. The economy, nonetheless, has yet to exhibit sustainable growth."
Recent signs of the economy's health remain mixed, including three reports yesterday. Sales of new homes soared last month to a record annual rate of 1.157 million, the Commerce Department said. And home resales rose slightly to an annual rate of 5.92 million, not far below the record 6.10 million rate set in January, according to the National Association of Realtors.
In contrast, new orders for durable goods, such as computers, trucks, machinery and defense equipment, fell 0.3 percent last month, after a 2.4 percent drop in April, the Commerce Department reported.
In addition to the reduction in the Fed's overnight rate target, the Fed Board cut the central bank's discount rate to 2 percent from 2.25 percent. The discount rate is the interest rate regional Fed banks charge on loans made to financial institutions.
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