The Federal Reserve Tuesday left short-term interest rates unchanged at their lowest levels in 45 years despite mounting evidence of the strongest economic growth in years as the central bank focused instead on the potential threat of falling prices.
The decision by Fed Chairman Alan Greenspan and his colleagues at the central bank was widely anticipated as policy-makers reiterated that their concern about the prospect of deflation would ensure that they keep rates low “for a considerable period” even as the economy rebounds.
The unanimous decision leaves the federal funds rate at 1 percent, its lowest level since the late 1950s. The benchmark rate, which represents what banks pay for overnight borrowing, is used by lenders to set a variety of consumer and business rates including the prime rate.
Only four words changed
Despite significant evidence of economic improvement since the last formal meeting of the Fed’s rate-setting panel Sept. 16, the central bank chose to alter only four words in the statement explaining its decision on rates, saying the labor market “appears to be stabilizing” rather than weakening.
The Fed’s faint praise of the economy, along with the fact that it retained its commitment to leave rates low for the foreseeable future, boosted stock prices and inspired a healthy rally on the Treasury market, sending long-term interest rates lower.
David Rosenberg, chief North American economist at Merrill Lynch, noted than since their Sept. 16 meeting policy-makers have seen a flurry of upbeat data, including a steady decline in new claims for unemployment benefits, improved consumer and business confidence and the first increase in U.S. employment in eight months.
“If all that elicits out of the Fed is three words of change in the press statement, you can only imagine what it’s going to take to get the Fed to move into a tightening cycle,” he said. “It’s going to take an absolute tidal wave of strong economic data.”
He pointed out that after the 1990-91 recession Greenspan’s Fed left short-term rates unchanged for 17 months after the final rate cut, waiting until the economy had added 3 million jobs.
The central bank lowered its benchmark rate to the current level June 25, but although the recession technically ended in November 2001, the economy is still more than 2.5 million jobs shy of the peak achieved before the downturn.
Fresh evidence of growth
After several false starts, the economy appears to have rebounded strongly over the past several months, and the Commerce Department is expected to report Thursday that the economy grew in the third quarter at its fastest pace in nearly four years.
In the latest evidence of continuing growth, a government report Tuesday showed that orders for long-lasting durable goods rose in September for the fourth time in five months, and consumer confidence rose more than expected as Americans grew slightly more optimistic about the current situation and employment prospects.
Some economists caution that the latest results have been boosted by the unique combination of lower tax rates, low mortgage rates, a declining dollar and $13 billion in child tax credit payments. Without sustained growth in employment, growth could sputter again next year.
Still, some analysts are beginning to question the Fed’s stated concern over what it calls the possibility of an “unwelcome fall in inflation,” which in a worst-case scenario could lead to a destabilizing downward spiral of prices, or deflation.
“I think the Fed overemphasized the risk of deflation, and now they are making a mistake in continuing to emphasize the risk,” said Sung Won Sohn, chief economist of Wells Fargo. “All indications are that inflation is going to be a problem — not disinflation.”
He said the Fed has “backed itself into a corner” by promising to keep rates low for a “considerable period.”
PNC Financial chief economist Stuart Hoffman disagreed, noting that the Fed has never defined “considerable period,” so even if central bankers begin raising rates again early next year they would be living up to their commitment.
He and many other forecasters do not expect the Fed to begin raising rates until much later in 2004, and possibly not until after the presidential election.
“The economy could grow quite rapidly for some period of time before their concerns about lower inflation would be off the table,” Hoffman said.
”(Fed officials) are probably very happy to see a strong quarter of GDP growth, but before they will react to it or call attention to the inflationary consequences they have got to see a lot more than one strong quarter that, let’s face it, was pump-primed by tax cuts and mortgage refinancing,” he said. “The next three to six months will show whether we have a more self-sustaining recovery.”
Full text of Fed statement
The Federal Open Market Committee decided today to keep its target for the federal funds rate at 1 percent.
The Committee continues to believe that an accommodative stance of monetary policy, coupled with robust underlying growth in productivity, is providing important ongoing support to economic activity. The evidence accumulated over the intermeeting period confirms that spending is firming, and the labor market appears to be stabilizing. Business pricing power and increases in core consumer prices remain muted.
The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. In contrast, the probability, though minor, of an unwelcome fall in inflation exceeds that of a rise in inflation from its already low level. The Committee judges that, on balance, the risk of inflation becoming undesirably low remains the predominant concern for the foreseeable future. In these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period.
Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Ben S. Bernanke; Susan S. Bies; J. Alfred Broaddus, Jr.; Roger W. Ferguson, Jr.; Edward M. Gramlich; Jack Guynn; Donald L. Kohn; Michael H. Moskow; Mark W. Olson; Robert T. Parry; and Jamie B. Stewart, Jr.