Fed votes to hold key interest rate steady

Decision ends series of cuts

board notes concern for inflation

June 26, 2008|By New York Times News Service

Caught between inflationary pressures and a weakening economy, the Federal Reserve's policymakers voted yesterday to deal primarily with the weakening economy by keeping interest rates at their present level.

The decision to hold at 2 percent the key short-term federal funds rate - which affects what consumers pay for mortgages, car loans and other credit - brought to a halt a stream of rate cuts since August, reductions that brought the fed funds rate to its lowest level since November 2004.

The halt signaled concern among policymakers that they might have to reverse course by the end of the year if rising oil prices push up the prices of goods and services across the economy. Apart from significant increases in food and energy, that has not happened. Still, the Fed in its statement after the meeting expressed greater concern about inflation than it had after its last meeting in April.

"Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased," the statement said. "The committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability."

The Fed's decision came as reports this week showed that home prices and consumer confidence continued to decline as foreclosures multiply. There have been signs that the economy might be stabilizing, but the latest data suggested that the economy was still unwinding. A rising unemployment rate and shrinking payrolls as employers shed workers have reinforced the impression of an economy still in need of help.

"I don't think we are out of the woods yet, and I don't think the Fed does either," said Lyle E. Gramley, a former Fed governor who is now a senior adviser at the Stanford Washington Research Group.

Trying to revive the economy, the Fed has cut interest rates to its present level of 2 percent from 5.25 percent in August, doing so at each of its policy meetings and at emergency sessions between meetings in the early days of the crisis over the credit markets. The reductions have helped. The economy has continued to grow, although not by much. But it has avoided the outright contraction that marks a recession.

And the Fed's new lending practices, hastily put together last fall, have channeled loans not only to banks, to encourage them to continue lending, but to investment houses that otherwise might collapse.

In the midst of this rescue process, surging oil prices have threatened to raise the inflation rate and the Fed policymakers, starting with the chairman, Ben S. Bernanke, recognized this problem in recent speeches, suggesting to Wall Street that the Fed might raise rates. The policymakers, however, "were surprised by the intensity of the market's reaction," as Ian Sherpherdson, chief U.S. economist for High Frequency Economics, put it in a newsletter.

And Nigel Gault, chief domestic economist at Global Insight, added: "At this point, most of Wall Street wants low rates because the financial sector is in trouble and low rates help that sector."

So the Fed's policymakers backed off in subsequent comments, signaling that they would not raise rates in the near term, thus making credit more expensive, or lower them, an indication that 2 percent is low enough to stimulate spending on credit even in a weak economy.

"They are trying to balance concerns about growth against inflation risks," Gault said, "and their answer for the moment, from most of the policymakers, is that the inflation risk is not big enough to warrant raising rates right now."

Bernanke has often expressed his concern that failure to act or to signal the Fed's determination to suppress inflation would raise "inflationary expectations," which means that the public comes to expect prices to keep rising and acts accordingly. This was an issue in the late 1970s, when companies raised prices and workers demanded and received wage increases. Another price increase set off another round of rising wages and in a resulting wage-price spiral, inflation got out of hand - until the Fed, led then by Paul A. Volcker, suppressed it with huge rate increases that pushed the economy into a steep recession.

This time, many economists say, a wage-price spiral is not possible because workers lack the bargaining power, particularly the union bargaining power, to push up wages.

"There isn't a wage-price spiral," Gault said. "The public might come to expect a rising inflation rate, but it isn't likely to have much influence on wage setting."

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