Wednesday, April 30, 2008

AP: Fed cuts rates as economy slumps, hoping to stop recession

The following AP story appeared on Yahoo Finance at 7:41 p.m. on Wednesday April 30, 2008

By JEANNINE AVERSA, AP Economics Writer

WASHINGTON - Scrambling to shore up the faltering economy, the Federal Reserve cut interest rates to the lowest point in nearly four years Wednesday as the nation teetered on the edge of recession.

Wall Street rallied at first but then pulled back, concerned that the reduction might be the last for a while.

In fact, the Fed's trim was smaller than those of recent months amid indications the central bank might pause to see if months of powerful rate-cutting medicine and billions of dollars in stimulus checks will be enough to lift the country out of its slump.

Chairman Ben Bernanke led a divided Fed, in an 8-2 vote, in slicing its key rate by one-quarter percentage point to 2 percent.

In turn, the prime lending rate for millions of consumers and businesses fell by a corresponding amount, to 5 percent. The prime rate applies to certain credit cards, home equity lines of credit and other loans. Both rates are the lowest since late 2004.

The Federal Reserve, which has been dropping rates since last September, turned much more forceful early this year when housing, credit and financial problems worsened. Rate reductions in January and March alone marked the most aggressive intervention in a quarter-century in an effort to re-energize consumers and businesses.

"The substantial easing of monetary policy to date ... should help to promote moderate growth over time and to mitigate risks to economic activity," the Fed said, strongly hinting that more cuts may not be needed.

Enthusiastic Wall Street investors drove the Dow Jones industrial average up more than 178 points — lifting it above 13,000 for the first time since early January — right after the Fed action. Then traders' caution returned, and the index ended the day 11.81 points below where it started.

Although the Fed didn't take another reduction off the table, a growing number of economists believe the central bank is winding down its rate-cutting campaign. Barring another hit to economic growth, they believe rates probably will stay where they are — perhaps through the rest of this year — in part because the Federal Reserve is concerned that further cuts could join with galloping energy and food prices and spread inflation dangerously higher.

By all accounts, the country's economic health is fragile.

The economy crawled ahead at a pace of just 0.6 percent from January through March as housing and credit problems forced people and businesses to hunker down, the Commerce Department reported hours before the Fed's action. Growth had been just as feeble in the prior quarter.

Job losses for the first three months of the year neared the staggering quarter-million mark, and a government report on Friday is expected to show that employers shed jobs again in April. The unemployment rate, now at 5.1 percent, also could creep higher in April and hit 6 percent early next year, analysts say.

"Recent information indicates that economic activity remains weak," the Fed said. "Household and business spending has been subdued, and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters."

Two members — Charles Plosser, president of the Federal Reserve Bank of Philadelphia, and Richard Fisher, president of the Federal Reserve Bank of Dallas — opposed cutting rates Wednesday, a crack in the usually unified front the Fed often shows the public.

Both men have a reputation for being especially vigilant about fighting inflation. At the Fed's previous meeting in March, they opposed cutting rates by a whopping three-quarters point and preferred a smaller reduction.

"The Fed didn't completely shut the door on rate cuts but they closed it part way," said Mark Zandi, chief economist at Moody's "I think the overall message was they've done a lot already to help the economy and think this will be enough. But they stand ready to do more if that is needed."

Bernanke's juggling act is getting harder. Fed policymakers are trying to bolster economic growth, and at the same time they are mindful that they can't let inflation get out of hand. The very rate reductions the Fed depends on to energize the economy can also sow the seeds of inflation down the road.

At the same time, many economists believe the economy already is declining.

Under one rough rule, if the economy contracts for six straight months it is considered to be in recession. However, that didn't happen in the last recession — in 2001. A panel of experts at the National Bureau of Economic Research that determines when U.S. recessions begin and end uses a broader definition, taking into account income, employment and other barometers. The bureau's finding is usually made well after the fact.

The Fed's previous rate reductions, which take months to work their way through the economy, should help lift growth in the second half of this year. The government's $168 billion economic-stimulus package — including tax rebates that started flowing to bank accounts on Monday — also should help energize activity, the Bush administration, Bernanke and private economists have said.

The biggest weight on the economy is the housing crisis, which has pushed foreclosures to record highs and caused financial institutions to rack up billions of dollars in losses.

For mortgage rates, the Fed's latest cut probably won't have much, if any, impact.

Rates on longer-term 30-year and 15-year mortgages, which are linked to the 10-year Treasury notes, actually could see rates rise in the weeks ahead in part because of concerns about higher inflation. Rates on shorter-term mortgages probably won't drop either because investors already had factored in the latest Federal Reserve action.

Still, people with adjustable-rate home loans have been helped by the Fed's series of rate reductions; they would have been socked with much higher rates when their mortgages reset if not for the Federal Reserve cuts, analysts said. "Going forward, if the Fed holds rate steady, resets in the pipeline would benefit in a similar fashion as still-low interest rates would mean very manageable mortgage-rate resets," said Greg McBride, senior financial analyst at

Monday, April 28, 2008

WSJ: The Fed's Bender

The following appeared on page A18 of the Monday April 28, 2008 issue of the Wall Street Journal.

So Federal Reserve officials are whispering to reporters that they will consider a "pause" after another interest-rate cut this week. Perhaps we should be more respectful, but this sounds like the alcoholic who tells his wife he'll quit drinking next weekend, after one more bender. What Chairman Ben Bernanke needs isn't a gradual withdrawal from easy money but membership in Central Bankers Anonymous.


Eight months into the Fed's most recent rate-cutting spree, the evidence is overwhelming that it has been a major policy mistake. Aggressive rate cutting - taking the fed funds rate to 2.25% from 5.25% last September - has had little effect on the banking crisis it was supposed to ease.

The recent progress on that front has come principally from the Fed's discount window innovations, especially its lending to investmetn banks in the wake of the Bear Stearns rescue. That is the kind of targeted liquidity that helps the financial system handle fears of bank failure and solvency without risking inflationary side-effects. The shame is that the Fed didn't do more of this earlier, along with tougher regulatory oversight of the likes of Citigroup. The way to save a troubled banking system is to focus on specific problems via dividend cuts, new management, losses in shareholder equity, rights offerings and other new capital, and if need be public money through the Federal Deposit Insurance Corp.

Meanwhile, the Fed's decision to open the general monetary spigots has inspired a global commodity boom unlike any since the 1970s. Oil has climbed to nearly $119 a barrel today from $70 in late August, a 70% increase. Farm and other commodities have seen a similiar surge, with corresponding increases in food prices leading to shortages and riots in Egypt and other places, and to rice hoarding even in Southern California.

The popular media explanation is that this price surge is a result of rising global demand, greedy speculators and human profligacy. All of sudden, without warning, the world is said to be running out of food. After 30 years in intellectual hibernation, Thomas Malthus and the Age of Scarcity are back in style.

No doubt commodity traders are having a field day, but what they are speculating on is the Fed's refusal to stop the free-fall of the dollar. The weak dollar has created another speculative bubble, this time in commodities. Oil prices have been surging despite only the usual geopolitical risks to global supplies and despite a recent International Energy Agency estimate the global oil demand will fall as growth slows.

As for food prices, it's true that government policies supporting biofuels have created new demand for corn and other grains. This and price controls in some countries have contributed to the food panic. But the price surge has been so rapid and so broad across nearly all commodities that it can't merely be a function of supply glitches or new demand for specific grains.

Like oil, world trading in most commodities is deonominated in dollars. When the dollar declines, especially as fast as it has since September, commoditiy prices surge and speculators gamble on even further declines. As the nearby chart shows, since 2003 the dollar price of oil has climbed far more rapidly than has the euro price - 273% in dollars, compared to 146% in euros. Note in particular the oil spike in dollars since the second half of last year. This reflects the European Central Bank's sounder monetary management. And it means that had the dollar merely retained the same purchasing power as the euro, today's price of oil would be below $70 a barrel.

The practical impact has been to send energy and food prices soaring. This is a direct tax on both the world's poor and America's middle class. Just when the U.S. economy needs a resilient consumer given the fall in housing prices, these price increases have eviscerated consumer pocketbooks. In its attempt to help Wall Street and the financial system, Fed policy is punishing average Americans. The public is frustrated and angry with these price increases, and it has a right to be. Inflation is the thief of the thrifty middle class.

The Fed's weak dollar policy ahs also done great harm to overall financial confidence, which is essential to any growth revival. A main source of the credit crisis is a lack of trust. Investors stop taking risks, bankers stop lending, and everyone flees to the safety of Treasurys or cash. But how can the Fed expect people to calm down and begin taking risks when it is clearly debasing the currency? Monetary easing itself also becomes less effective, because without confidence more liquidity is merely "pushing on the string," in the famous phrase.

The Fed's problem has been both political and intellectual. Politically, Mr. Bernanke has been unwilling to say no to Wall Street and the Beltway political class, which reflexively demand easier money in a crisis. This demand has become almost Pavlovian since Wall Street came to believe during the late 1990s in what was known, fairly or not, as the "Greenspan put." It takes character to resist this political pressure, but that is what Fed chairmen are supposed to have.

As for the intellectual problem, the Fed and much of Wall Street convinced themselves that the only inflation measure that matters is "core inflation," which excludes food and energy. The Fed's monks devised that measure to avoid an overreaction to commodity price movements, but instead they have used it to pretend that food and energy prices don't matter. Throughout this decade, they pointed to core infaltion to argue that "inflationary expectations remain well anchored," even as the dollar and commodity price signals were telling us that the opposite was true. Americans don't buy gas and groceries with "core" dollars.

In fairness to the Fed, it has had many allies in dollar-devaluation. The manufacturing lobby promoted it, as ever, to spur exports and profits, while the Bush Administration has acquiesced in the hope that it would reduce the trade deficit. (Oops.) The housing bubble was a societal mania brought on by the Fed's subsidy for credit, and no one wanted it to end. Even many of our supply-side friends dismissed concern about price signals and the falling dollar, focusing too much on the benefits of tax cuts and forgetting the monetary lessons of the 1970s. Some of these sages are finally coming around, but too late to prevent the economic and policy damage.

The ironic and unfortunate cost may be that political blame for rising prices and any recession will fall unfairly on Bush fiscal policy. As we've been writing for several years, the greatest threat to economic growth has been reckless monetary policy. Yet both the Bush Treasury and John McCain's campaign seem oblivious to the monetary roots of our current economic troubles.


As the Fed's open-market committee meets this week, what the world wants is a revivial of American monetary leadership. It wants the Bernanke Fed to stop the global run on the dollar, and that means declaring an end of its rate-cutting mistake.

Inflation may force Fed to ease up on rate cuts

The following appeared on page 5B of the Monday April 28, 2008 issue of the St. Paul Pioneer Press.

By Kevin G. Hall
McClatchy Newspapers

NEW YORK - A few weeks ago, financial analysts were certain the Federal Reserve would try to spark the economy with another half-point cut in interest rates when its policy-making committee meets this week.

Since then, however, soaring oil prices and food riots across the globe have raised fears that people at home and abroad are becoming convinced the world is entering an era of rising inflation, and they're adjusting their expectations and behavior as a result.

In light of that, if the Fed's rate-setting Open Market Committee does cut its benchmark federal funds rate - the rates that banks charge one another for overnight lending - it's likely to be only a quarter-point, to 2 percent, not the aggressive cut most analysts were projecting weeks ago. But it's also likely to signal it intends to pause a while before cutting rates again because inflation remains stubbornly high - even though the U.S. economy appears to be stalled.

Inflation, the rise of prices across the economy, remains a threat at home and abroad. The biggest part rises from the seeminly unstoppable climb in oil prices. But the prices of everything from grains and dairy products to base metals and raw materials also are surging. That drives up the price of nearly everything we eat, heat, cool, drive or manufacture.

That's bad news for the Fed, whose primary mission is to keep inflation low to preserve the buying power of U.S. consumers.

In recent weeks, there have been food riots in Egypt, Haiti and elsewhere as rising prices for globally traded commodities such as rice and corn have pushed up food prices. Corn prices are up 30 percent, and rice is up more than 50 percent so far this year. The prices of some U.S. staples such as eggs, are up about 30 percent since March 2007.

People in developing nations often spend more than half their incomes on food, and that's why their anger about rising prices is spilling onto the streets.

"This steeply rising price of food, it has developed into a real global crisis," United Nations Secretary-General Ban Ki-Moon said Friday, appealing for greater food aid.

Most Americans spend less than 10 percent of their incomes on food. But coupled with soaring prices for health care and oil, now above $118 a barrel, and with gasoline over $4 a gallon in some places, the middle-class American consumer is taking it on the chin.

"It does represent a change," said Peter Kretzmer, an economist in New York for Bank of America.

It also presents a dilemma for the Fed.

Three months of falling employment, flagging consumer confidence and a persistent housing crisis argue for more rate cuts to spark lending and reignite consumer spending. Traditionally, the Fed keeps cutting rates until unemployment has peaked.

"It would be unusual for the Fed to be on hold while that is happening," said Kretzmer.

The Fed normally has room to maneuver because a slowing economy douses the flames of inflation.

However, global oil and commodity prices keep rising, and they're being passed along to consumers and businesses. U.S. consumer prices were rising at a 4 percent annual rate in March, the latest reading. They're sure to have risen again in April, when oil leapt above $110 a barrel. Food prices rose 4.5 percent over the past 12 months; gasoline rose 26 percent.

Richard Fisher, president of the Federal Reserve Bank of Dallas, is worried people are beginning to expect rising inflation. That's why he's voted against further rate cuts at the last two Fed meetings.

In an interview last week with Fox Business News, he said that "really what we're dealing with are inflationary expectations. And what we're trying to make sure doesn't get out of control are the expectations of consumers and businesses, to begin imputing certain inflationary patterns, because then they'll be exacerbating inflation, and that's something certainly none of us wish to see."

Sunday, April 27, 2008

Surging food, fuel prices cloud inflation picture

The following Ed Lotterman article appeared in the Sunday April 27, 2008 issue of the St. Paul Pioneer Press on page 3D.

Even economists experience sticker shock. I just bought one gallon of skim milk and one of 2 percent at the corner store. I do this regularly, but $9.14 for two gallons of milk still seems like a lot.

I'm not alone. Millions of people perceive that rising fuel and food prices are crimping their families' standard of living. No wonder they get upset when monthly inflation numbers are released and some expert notes that "core inflation" is up only slightly. It contradicts their daily personal experience.

The problem stems from the misapplication of a statistical measure - core inflation - that is useful in some situations but misleading right now.

For 80 years, the U.S. government has tabulated price indices to measure changes in general price levels. The consumer price index is the best known, as it measures goods and services that households buy. Every month, the government checks prices on thousands of items. On the whole, the CPI is an accurate indicator.

But prices of some items jump around more than others. Both food and fuel are important for most households, so they have a lot of influence on the overall index. But their prices tend to fluctuate more in the short term than those of clothing, household goods, shelter or recreation.

The fluctuations, incorporated in something tabulated on a month-to-month basis, can mislead.

Suppose overall prices are increasing at an average annual rate of 3 percent. Items other than food and fuel may increase at a rate of 2.5 percent one month and 3.5 percent the next, but follow this 3 percent trend. Then suppose food and fuel increase at a rate of 6 percent one month and again unchanged the next. Again, the long-run trend is 3 percent.

If you just consider the month that food and fuel rose at a 6 percent rate, it will appear that inflation is hot. The next month it will look like inflation is non-existent. But in the longer run, the trend in food and fuel is about the same as for other goods.

One can avoid this confusion by measuring consumer prices generally, but then making a separate tabulation that excludes volitile items. Weighing the two tabulations together gives us a better picture.

That is why the "core inflation" tabulation was introduced, to allow analysts to factor out short-run volatility that might be misleading.

A problem arises, however, when the longer-term trend for food and fuel is not the same as for other items. Suppose other items increase at rates between 2 percent and 4 percent with a trend of 3 percent. Month after month, food and fuel fluctuate between 6 percent and 10 percent annual rates with an average trend of 8 percent. Just looking at core inflation blinds one to a larger problem.

Taking comfort in a measure designed to dampen short-run fluctuations can mislead one about true prices trends. Over most of the past 25 years, food and fuel pries ahve increased more slowly than everything else. In the last two years, however, they have increased faster, and the discrepancy is widening. Citing restrained core CPI numbers as evidence of constrained inflation assumes that food and fuel will soon be dropping. REalistically, that is not in the cards.

St. Paul economist and writer Edward Lotterman can be reached at

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