Lagging Expansion Gets Greater Fed Response

Federal Reserve officials, including Chairman Ben Bernanke, are signaling a more aggressive response to the increasing risk of recession.

Published on January 14, 2008

Bernanke is slated to testify before Congress on January 17, two days following a government report that economists predict will show retail sales stalled last month after a gain of 1.2 percent in November.

The Fed chief and Governor Frederic Mishkin unveiled the new response last week, when they said in speeches that they favor greater insurance against the prospect of an economic downturn. The new approach is seen as a departure from basing policy on central bank forecasts, which anticipate a continued expansion.

According to Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey, “The crucial change in Bernanke's language last week was the reference to the need for insurance.” Crandall says that until now, officials “have tended to describe the Fed’s rate cuts as being scaled to the size of the projected problem.”

Bernanke and Mishkin’s remarks are leading traders to increase bets the Fed will reduce its main interest rate by half a percentage point this month. The central bank has cut the benchmark rate by 1 percentage point since September.

While the Fed cut the benchmark rate in September by a half-point, more than the anticipated amount, it has refused to commit to a series of additional reductions, a refusal that has disappointed some investors.

Borrowing costs were lowered by a quarter point each in October and December, yet policymakers shied away from saying that growth was a bigger concern than inflation.

“They underestimated the magnitude of the credit shock,” said Brian Sack, senior economist at Macroeconomic Advisers LLC in Washington. “Now they are catching up.” Some traders are predicting at least a half-point cut in the target rate for overnight loans between banks this month.