INSIGHT: Nail-biting at the US central bank

08 January 2009 20:37  [Source: ICIS news]

By Joe Kamalick

WASHINGTON (ICIS news)--US central bank officials worry that the country’s recession could become self-sustaining and drag the nation into what some fear could be a prolonged economic depression.

In the minutes of the Federal Reserve Board’s rate-setting meeting of 15-16 December, the central bank’s staff economists and board governors reveal great concern over near-term prospects for the economy, with unemployment continuing to rise through this year and into 2010.

And while the central bank economists and governors suggest - none too strongly - that a moderate recovery will develop in 2010, that forecast depends heavily on hopes that a stimulus package soon to be passed by Congress will turn the economy around.

But don’t count on it, the central bank officials said.

In the forecast for the December rate-setting meeting, the Fed’s economic specialists reported that “Real GDP appeared likely to decline substantially in the fourth quarter of 2008 as conditions in the labour market deteriorated more steeply than previously anticipated”.

“The decline in industry production intensified, consumer and business spending appeared to weaken, and financial conditions, on balance, continued to tighten,” the analysis said.

“Rising unemployment, the declines in stock market wealth, low levels of consumer sentiment, weakened household balance sheets and restrictive credit conditions were likely to continue to hinder household spending over the near term,” the Fed report said.

Bearing in mind that consumer spending represents something like 8 cylinders of the 12-cylinder US economic engine - accounting for as much as 70% of all commercial activity - that Fed outlook is dire indeed.

It was because of those morose forecasts that the Fed took the unprecedented action on 16 December to lower its key federal funds interest rate to the range of 0% to 0.25%.

The Fed seemed broadly concerned that the recession could become self-sustaining and tip over into a full-blown recession. Worried about the future and their jobs, consumers limit their spending, which in turn lowers demand still further, triggering more layoffs and making households even less likely to spend.

The Fed analysis noted further that “homebuilding was expected to contract further [and] business expenditures were also likely to be held back by a weaker sales outlook and tighter credit conditions”.

“All told, real GDP was expected to fall much more sharply in the first half of 2009 that previously anticipated,” the Fed said.

The central bank’s analysts said they expect the US economy would slowly recover in late 2009 and into 2010 “as the stimulus from monetary and assumed fiscal policy actions gain traction”.  (Emphasis added.)

Even assuming that the stimulus package is passed and has the intended effect - which is assuming a lot - the Fed governors are not all that confident that the economy will recover.

Referring to the rate-setting discussions among the board members and staff experts on 16 December, the meeting minutes note that “Participants expected economic activity to contract sharply in the fourth quarter of 2008 and in early 2009 [but] most projected that the economy would begin to recover slowly in the second half of 2009, aided by substantial monetary policy easing and by anticipated fiscal stimulus”.

But then the caveat:  “Meeting participants generally agreed that the uncertainty surrounding the outlook was considerable and that downside risks to even this weak trajectory for economic activity were a serious concern.”

Translated from Fed-speak, that means the wheels could come off at any time.

($1 = €0.74)

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By: Joe Kamalick
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