In Fed's Decision to Slash Rates, Fears of a Long Recession

By JACK HEALY
The New York Times
Published: Jan 07, 2009

As Federal Reserve officials met last month to confront the deepening recession, they worried that even a dramatic cut in interest rates and unprecedented new measures in monetary policy would not be enough to cauterize the country’s economic troubles quickly.

“Even with the additional use of nontraditional policies, the economic outlook would remain weak for a time and the downside risks to economic activity would be substantial,” the officials concluded, according to minutes from the most recent meeting of the Fed’s Open Market Committee, released Tuesday.

The details of the December meeting shed some light on the central bank’s mood as it made the unprecedented decision to cut interest rates to a range of zero to 0.25 percent from 1 percent, effectively lowering the cost of money to nearly nothing as they tried to kick-start credit markets and encourage borrowing.

“The overwhelming message gleaned from the minutes of the meeting is one of fear — fear of a deep recession, and fear of a debilitating deflationary spiral that would capsize a debt-laden economy,” Joshua Shapiro, chief United States economist at MFR, wrote in a note.

Members of the committee agreed that the recession had only deepened during the autumn as shocks from the financial crisis rippled through the broader economy. Inflation had all but vanished, and Fed officials worried that “decline and persist for a time at uncomfortably low levels.”

They said that economic contraction would continue through the first quarter of this year, but most predicted that the economy would begin to recover during the second half of the year, with help from a government stimulus plan.

Unable to cut interest rates below zero, Fed officials also discussed how they could address the financial crisis using balance-sheet measures, such as buying up billions in Treasury debt or securities backed by Fannie Mae and Freddie Mac.

“Many participants thought that the Federal Reserve should continue to consider whether expanding some of the existing facilities and creating new facilities could be helpful,” the Fed minutes say.

In announcing its decision on the target for overnight interest rates, the Fed said that “weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time” and it said it would do whatever it could to revive the economy. Since the Fed’s rate cut on Dec. 16, rates on 30-year fixed mortgages have dropped to 5.1 percent, their lowest in more than 30 years, from 6.07 percent a year ago, according to Freddie Mac, the government-controlled mortgage giant.

But as they met, Fed officials acknowledged that while a drastic decrease in interest rates could stimulate “aggregate demand and economic activity,” it also had potential downsides in the function of “certain financial markets and some financial institutions,” such as money market funds.

“Most participants judged that the benefits in terms of support for the overall economy of federal funds rates close to, but slightly above, zero probably outweighed the adverse effects,” the Fed officials said, according to the minutes.

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