Fed fears extended contraction despite radical moves
WASHINGTON -- Federal Reserve officials worried about the possibility of a "prolonged contraction" and destabilizing deflation in mid-December when they voted to cut a key interest rate to a historically low range of zero to a quarter-point.
According to minutes of the Fed's Dec. 15-16 meeting, released Tuesday, central bank economists sharply reduced their forecast for the economy due to spiking unemployment; declining manufacturing, consumer and business spending; and constrained credit markets. Some Fed officials worried about a growing risk of deflation — a widespread, sustained decline in prices — as the economy cools and commodity prices fall.
Fed officials generally expected the sharp downturn to continue through mid-2009, with a slow recovery thereafter, aided by their interest rate cuts and new spending and tax cuts. Even that dismal outlook is questionable, according to the minutes, given the "substantial" economic risks.
"The severe ongoing financial market strains, the large reductions in household wealth and the global nature of the economic slowdown were seen by some participants as suggesting the distinct possibility of a prolonged contraction, though that was not judged to be the most likely outcome," the minutes said.
The central bankers' concerns were underscored by economic reports Tuesday showing a decline in factory orders and activity in the huge services sector. The government Friday will release the December employment report, which is expected to show a major rise in joblessness.
President-elect Barack Obama on Tuesday pushed Congress to move quickly on a $775 billion stimulus package while acknowledging that the nation faces trillion-dollar deficits even with a recovery.
During their meeting, Fed officials discussed at length how to boost the economy with interest rates, their preferred tool, near zero.
Fed Chairman Ben Bernanke has led the central bank well beyond traditional boundaries in the past year by creating lending programs to shore up banks and specific markets, including mortgage, auto and college loan programs. The moves have expanded the Fed's balance sheet from $800 billion to more than $2 trillion. Fed officials say they will need to keep their balance sheet high for some time and could buy securities such as Treasury bonds to reduce longer-term interest rates.
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