Fed hints loudly it won’t cut rates

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Short-term interest rates are expected to remain unchanged after the Federal Reserve’s rate-setting committee meets today. For full coverage after the Fed meeting,
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Worried investors have expressed hunger for a rate cut to stimulate the economy. Fed officials responded in early September with a flurry of speeches that crushed expectations of a rate cut. At the Chicago Board of Trade, futures traders have priced in a 10 percent probability that the Fed will reduce short-term rates this month.

The Federal Open Market Committee meets roughly every six weeks to review the Fed’s interest rate policy. The body’s primary monetary policy tool is the federal funds rate, also known as the overnight rate because it’s what member banks charge one another for overnight loans to cover reserves.

The Fed’s target for the overnight rate is 1.75 percent, a 41-year low. It has remained at 1.75 percent since December. The prime rate, which banks charge to their biggest and best customers, is pegged to the overnight rate. And some types of consumer debt, such as credit cards and home equity loans, are based upon the prime rate. Right now the prime rate is 4.75 percent.

During the spring and early summer, economists and investors had expected the Fed to raise the overnight rate by now to ward off inflation as the economy heated up.

But the economy has stayed lukewarm. Inflation has been a low 1.8 percent over the last year, business investment hasn’t picked up as much as had been expected, and weekly unemployment claims have topped 400,000 for four weeks in a row.

Investors looked at those grim numbers this summer and hoped that the Fed would cut interest rates to encourage businesses to borrow, invest in new equipment and hire people. The Fed encouraged such speculation when it issued a statement after the last rate-setting meeting, on Aug. 13, that said, “the risks are weighted mainly toward conditions that may generate economic weakness.”

But the week of Sept. 9, three Federal Reserve Bank presidents made speeches in which they implied that the economy doesn’t need a rate cut.

“The Fed’s monetary policy stance is quite accommodative,” San Francisco Fed President Robert Parry said at a meeting Sept. 12 in Salt Lake City. In Fedspeak, an accommodative monetary policy means interest rates are low and designed to stimulate the economy.

“Given what we know about economic conditions, an accommodative stance seems appropriate to me,” Parry said, adding that “our current policy stance can promote the economy’s expansion without sacrificing the gains we’ve made against inflation.”

Three days before Parry’s speech, two other Fed bank presidents spoke. Michael Moskow, president of the Fed of Chicago, said, “the economy is still experiencing uncertain times. The road to recovery is turning out to be bumpy. Now, the Fed cannot — and should not — try to smooth out every bump.”

He said he expects economic growth to pick up over the next few quarters.

The same day, the Boston Fed’s president, Cathy E. Minehan, said she expects the economy to pick up slowly. She said, “Monetary policy is in an accommodative stance, helping to stimulate interest-sensitive sectors and maintain consumer spending.” But, she added, as economic growth strengthens, “the stance of policy will need to be more consistent with stable inflationary growth over time.” In other words, the Fed will have to raise short-term rates when it is confident that the economy is picking up.

Those don’t sound like the words of people who want to cut interest rates further. On the other hand, none of the three bank presidents who spoke is a full voting member of the Open Market Committee. Moskow and Parry are alternate members. Minehan is not a member of the committee.

Richard DeKaser, chief economist for National City, says flatly that the Fed is done with cutting rates, and he believes that’s a wise policy. He notes that, for a month, Fed policy-makers have been making speeches downplaying the possibility of a rate cut. “Things like this don’t happen by accident,” he says.

— Posted: Sept. 20, 2002