- The Washington Times - Thursday, May 8, 2003

The White House reacted calmly yesterday to the Federal Reserve’s extraordinary statement that falling inflation poses the risk of setting off a downward spiral in the economy — a potentially disastrous trend for any president facing re-election.White House Press Secretary Ari Fleischer said administration economists are examining the issue, noting wryly that Fed statements “are sometimes cryptic, and they require considerable study.”Few Fed pronouncements have been as difficult to interpret as Tuesday’s, in which the Fed said it is prepared to cut interest rates again partly out of concern that any further substantial drop in inflation would pose a danger for the economic recovery.Fed-watchers debated the meaning, with many saying the statement was not intended to raise public alarm but rather was aimed more at engineering the decline in the dollar and market interest rates that it provoked.One thing is not in dispute. As a result of the Fed’s new stance, “it’s going to be a long time before they’re going” to raise rates, even if the economy does recover, said Kevin McKenna, a bond fund manager at Merrill Lynch Investment Managers.The Fed issued what amounts to a guarantee to bond investors that it will not raise interest rates at the next sign of a pickup in inflation, because it is more concerned about lagging growth, and even a potential fall in prices, than it is about inflation for the foreseeable future.That “gives people more confidence to buy” Treasury bonds, Mr. McKenna said, because they won’t be afraid of a sudden jump in interest rates that wipes out the value of the bonds. Treasury rates declined again yesterday as investors bought bonds and basked in the Fed’s assurances.Bond rates, which are set by the markets and are not directly controlled by the Fed, are a critical link in the economy because they are used to set the rates on 30-year mortgages.The lowest mortgage rates in decades have been fueling growth in one of the only strong sectors of the economy — the housing market — and have touched off a record refinancing wave that has freed up billions of dollars for consumers to spend. Both have provided critical support for the economy in the last two years.Analysts said the Fed undoubtedly wants to prevent a spike in mortgage rates that could kill the refinancing spree and home-sales boom, once the rest of the economy starts to recover from its sluggishness — and that could be behind the Fed’s unusual statement.Tony Crescenzi, chief bond market strategist with Miller, Tabak & Co., said the Fed is trying to prevent a deflationary spiral from developing by alerting the markets to that possibility, concededly a “minor” one, and showing the central bank is prepared to act if the danger becomes real.”If they persist with that message, that could help lift business confidence and investor confidence,” he said. “I don’t think people need to worry too much.”The Fed’s remarks also appeared to seal the recent declining trend in the dollar, with many analysts predicting the currency will continue to fall as long as the Fed refrains from raising interest rates. That could be months or even years.The Fed’s statement prompted the administration’s chief spokesman on the dollar, Treasury Secretary John W. Snow, to say that the administration has not changed its stance.”Our position on the dollar going back many years is to support the strong dollar, but to recognize that the dollar’s value is best set in an open, competitive currency market,” he told CNBC yesterday.Such remarks have done little to deter the dollar’s fall against the euro in recent months. Yesterday, they served to stabilize the currency after a dramatic drop to $1.14 on Tuesday.While the administration is mostly mute about the deflation danger the Fed signaled, its drive for tax cuts has been aided by fears in some quarters that the drop in inflation recently to rates between 1 percent and 2 percent could portend a general free fall in prices and downward spiral in the economy.Seen against the backdrop of such an economic death trap, some economists argue that President Bush’s proposed $726 billion in tax cuts hardly would be enough to ensure he does not face the same fate as former President Herbert Hoover, whose tight budget policies during the Great Depression caused his re-election defeat.”The U.S. economy, and with it the global economy, is poised on a knife-edge,” said John Makin, economist with the American Enterprise Institute, who has been arguing that both the Fed and Congress should move forcefully to cut interest rates and taxes to boost consumer and business demand.”Sadly, policy-makers remain complacent, increasing the likelihood that demand growth will falter and recession will return,” he said. “The Fed’s waiting-game approach to further stimulus is a risky one with a substantial downside.”Congress has been dithering in the face of disaster, Mr. Makin said.”The reduction in the size of President Bush’s stimulus package, effectively … to about $350 billion, is a move in the wrong direction,” and will barely compensate taxpayers for the out-of-pocket cost of energy price increases earlier this year, he said.

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