April 8, 2009 in Business

Danger of worsening recession drove Fed action

Associated Press
 

WASHINGTON — Faced with the danger of a worsening recession, Federal Reserve policymakers at their March meeting took the bold step of plowing $1.2 trillion into the economy to drive down interest rates and entice Americans to start buying again.

Documents released Wednesday provided insights into the Fed’s decision to revive the economy by buying long-term government debt and boosting purchases of mortgage-backed securities from Fannie Mae and Freddie Mac.

“Most participants viewed downside risks as predominating in the near term,” according to minutes of the Fed’s closed-door meeting on March 17-18.

That risk came mainly from a vicious cycle where rising unemployment prompted cutbacks by consumers, which in turn led to more layoffs and reduced production by businesses. Such forces would weaken the economy even more, triggering further credit tightening and additional losses at financial institutions, the Fed explained.

Against that backdrop, the central bank decided to hold its key bank lending rate at a record low of between zero and 0.25 percent. Economists predict the Fed will hold the rate in that zone for the rest of this year and for most — if not all of — next year.

In addition, Fed Chairman Ben Bernanke and his colleagues turned to other unconventional tools to revive the economy. The Fed said it would spend up to $300 billion to buy long-term government bonds and would buy an additional $750 billion in Fannie and Freddie securities.

The economy had deteriorated more than Fed policymakers expected from their previous meeting in January. Of particular concern was the sharp drop in demand overseas, which was hurting sales of U.S. exports, the Fed said. That meant exports wouldn’t likely be a source of support for economic activity in the near term.

Projections for economic activity in the second half of 2009 and in 2010 “were revised down” by the Fed’s staff, according to the minutes. It did not provide updated forecasts.

It said that gross domestic product, or GDP, was “expected to flatten out gradually over the second half of this year and then to expand slowly next year as the stresses of the financial markets ease, the effects of fiscal stimulus take hold, inventory adjustments are worked through and the correction in housing activity comes to and end.”

GDP measures the value of all goods and services produced within the U.S. and is the broadest measure of the country’s economic health. GDP contracted at a 6.3 percent pace in the final quarter of last year, the worst showing in a quarter-century. Many economists expect it performed nearly as poorly in the first three months of this year.

The government will release its estimate of first-quarter GDP later this month. Many analysts believe the economy is shrinking in the current quarter, but probably not as much as in the fourth quarter.

With the economy likely to stay fragile, the unemployment rate — now at a quarter-century high of 8.5 percent — will probably “rise more steeply into early next year before flattening out at a high level over the rest of the year,” the Fed minutes said.

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