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Fed Makes Another Rate Cut to Boost Economy

October 31, 2007 at 6:45 PM EDT
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JEFFREY BROWN: Even in recent days, there have been conflicting signs about the health of the economy, and the Fed said it weighed those different considerations today.

On the positive side: solid economic growth and calmer financial markets. On the down side: a potential slowdown in economic expansion and growing concerns about inflation.

We parse the words and numbers now with David Wessel, economics editor of the Wall Street Journal.

Welcome.

DAVID WESSEL, Wall Street Journal: Thank you.

JEFFREY BROWN: Start on the growth area. What were they seeing that worried them?

DAVID WESSEL: Well, the Fed came into this meeting today knowing that the economy was pretty strong in the third quarter. The government said today it grew at a robust 3.9 percent rate, but the housing problem is a lot worse than people anticipated.

So housing is worse. Oil prices are higher, and that can have a depressing effect on the economy. And there are some signs that this credit crunch is beginning to bite in other parts of the economy besides mortgages.

Substantial slowdown in growth

JEFFREY BROWN: So, I mean, it's an interesting day, because on the one hand, as you say, they come out and say growth has been pretty good, but they're looking ahead.

DAVID WESSEL: They're looking ahead. And the Federal Reserve, like most private economic forecasters, sees a very substantial slowdown in economic growth in the current, the fourth quarter.

JEFFREY BROWN: And, in fact, some people have even become to use the r-word, right, recession looking ahead?

DAVID WESSEL: Right. I think most people agree that the risks of recession have risen substantially. Where people differ is some people think it's likely. I wrote a column in the Wall Street Journal saying I thought it was likely. But the consensus is we're going to get by without one.

JEFFREY BROWN: So the Fed lowers the fed funds rate by a quarter of a percentage. Explain to us how that impacts the economy. What are they trying to do?

DAVID WESSEL: What the Fed is trying to do is make credit a little cheaper in the economy so that people, whether they're consumers or businesses, find it a little easier to borrow. And what they're trying to do is, by lowering the interest rate, the short-term interest rate, which is a benchmark for a lot of short-term interest rates in the markets, is offset this unwelcome tendency of lenders to be a little more cautious because of the whole subprime debacle.

JEFFREY BROWN: Does it impact the housing market?

DAVID WESSEL: It doesn't impact the housing market directly. It will make it easier for people to draw down their home equity lines. It will be a little cheaper. And if it filters through to the bond mark, it can make mortgages a little cheaper.

It could be a big help to people who have adjustable rate mortgages which are resetting. Those aren't very sensitive to short-term rates.

Confusion over rate cut

JEFFREY BROWN: I was watching, when they announced this, the stock market at the beginning did very little and then suddenly took off.

DAVID WESSEL: Yes, that was a bit of a surprise. I think the markets were very confused about whether the Fed was going to really cut interest rates. The Fed cut interest rates, and the stock market fell.

And the only explanation I can think of is that the language that the Fed used indicated that, contrary to market expectations, they are not planning on cutting rates again this year unless things really get worse. But then, by the end of the day, the market was happy again, and it was up more than 100 points. So go figure.

JEFFREY BROWN: Well, OK, because that leads us to the other side of the Fed's statement, which is some concern about inflation. Now, where are they seeing that?

DAVID WESSEL: Well, what the Fed sees is that energy prices, and food prices, and other commodity prices are rising. Fed Chairman Bernanke has in the past said he doesn't see any evidence that that's spilling over to the rest of the economy yet, but maybe some of the other people on the Federal Reserve Board and the presidents of the Federal Reserve banks that participate in these deliberations disagree.

So it was a warning that the Fed is in a very difficult position. They see risk to growth on one side, the rising odds of recession. But on the other side, they're a little worried that this commodity price increase, oil price, food price thing might spill over to inflation overall. And, of course, their job is to prevent that from happening.

Concerns about inflation, recession

JEFFREY BROWN: Because this is a little jarring, right? Because when the Fed was worried about inflation, usually they're not cutting rates.

DAVID WESSEL: That's right. It's a good thing it's Ben Bernanke's job and not you or mine. They're in a very difficult position. They start from interest rates that are high enough to be able to cut some, but I think going forward they're going to be watching sort of these twin evils of recession and inflation. And they may find that they can't keep cutting rates even though they'd like to.

JEFFREY BROWN: Now, you were suggesting that they were sending a message that this may be the end for now. What makes you say that?

DAVID WESSEL: That's right. Well, at the end of every -- there's a kind of kabuki dance that the Fed does. People try and guess what they're going to do. They trade on it. They look at Fed speeches. Then the Fed has a meeting. And in their current regime, they put out a very short statement.

And this time, the statement said that the risk to inflation on the upside roughly balanced the downside risk to growth. So that's a recipe in Fed-speak for doing nothing.

So I think they were pretty clear: They are not anticipating more interest rate cuts unless the economy really deteriorates, the forecast really deteriorates, or something happens on oil prices and food prices that make them think that inflation is much less likely.

Comparing Bernanke and Greenspan

JEFFREY BROWN: You mentioned Fed-speak, and you mentioned Ben Bernanke. It's always interesting. We've talked about this before. He's still relatively new. We're still getting used to him as opposed to Alan Greenspan and trying to parse what he said.

What change do you see right now, I mean, in this kind of action, two cuts this quickly in Ben Bernanke? Does that help you read him better for the future?

DAVID WESSEL: Well, I think that the markets were wondering whether Ben Bernanke was going to telegraph his moves as well as Alan Greenspan did. And if they hadn't cut rates, people would have said he misled us, and he's not as good as Greenspan at managing expectations. So this takes care of that problem. They expected a rate cut; they got one.

I think the decision itself and the language they used in the statement is no different than what would have happened if Alan Greenspan were chairman, but I think there are differences. And two big ones are, one, we know he's a much more collegial guy at the Fed, much less taking his own counsel and participating with more of the other officials in give-and-take.

And the other thing we know, that he has this idea that you can somehow do one thing to stabilize financial markets and another thing to keep the economy growing. He thinks that the Fed's two jobs can be distinguished; I don't think Alan Greenspan sees it quite the same way.

But I'd say for now he's passed his first crisis with passing marks, although he's got critics on both sides. Some people say he didn't move quick enough, and other people say he's bailing out the speculators and the hedge funds by cutting rates.

JEFFREY BROWN: All right. And their next meeting is December, I think, right?

DAVID WESSEL: Right, not until December.

JEFFREY BROWN: OK, David Wessel, Wall Street Journal, thanks again.

DAVID WESSEL: You're welcome.