Fed enters key meeting with no clear path

John W. Schoen Senior producer • Profile • E-mail

Just one week after an emergency three-quarter-point interest rate cut to calm jittery global financial markets, the Federal Reserve’s rate-setting committee sits down Tuesday to figure out its next move.

While many investors are expecting another aggressive interest rate cut — up to half a point — to help lift the economy out of the doldrums, another cut is far from a sure bet, according to some former members of the panel, known as the Federal Open Market Committee.

Last week’s dramatic move came as pressure had been building after a series of weak economic data suggested the economy might be heading into recession.  As global stock markets began to tank, the Fed took the unusual step of acting between regularly scheduled meetings of policymakers.

For the moment, the move appears to have calmed the markets. But it’s far from clear whether the time is right for deeper cuts, as some analysts are worried that an overly aggressive Fed could stoke inflation.

"This is an extraordinarily difficult situation. Uncertainty is very, very high," said Alice Rivlin, former Fed vice chair and now a senior fellow at the Brookings Institution. "One can argue that the Fed ought to do more in this situation, and one could argue that they’ve done enough already and they should start worrying about inflation."

The weakening economy has become the top issue on the campaign trail — and in the White House. In Monday night's State of the Union address, President Bush prodded Congress to adopt a $150 billion package of tax rebates for individuals and tax breaks for businesses, aimed at boosting the economy.

Tuesday's economic data didn't make the Fed's decision any easier. December durable goods orders were surprisingly strong, welcome news for the weakening economy. On the other hand, consumer confidence fell sharply in January. Also on Tuesday, the Standard & Poor’s/Case-Shiller 10-city composite home price index plunged by a record 8.4 percent.

Still, it’s not clear that the economy is headed for — or in — a recession. The Fed’s own forecast calls for slower growth in 2008 but stops short of projecting a recession, in which the economy would actually shrink. The Fed already has cut rates 1.75 percentage points since September and won’t know for months just how weak the economy really is.

“So many of these [economic downturns] are so much clearer when you look back than when you’re in the midst of it,” said Robert Parry, the former president of the San Francisco Fed, who served as a rotating member of the central bank's rate-setting panel.

For the time being, the Fed seems to be erring on the side of cutting rates. Fed Chairman Ben Bernanke signaled a clear shift in a speech this month, saying the Fed stood “ready to take substantive additional action as needed.” Now, a week after cutting rates by three-quarters of a point, the FOMC has to decide whether that move was "substantive" enough — or whether further cuts are needed.

If it turns out the economy has only hit a soft spot, cutting rates further may do more harm than good. Some Fed watchers argue that the current credit hangover is due, in part, to the policy of Bernanke's predecessor, Alan Greenspan, who lowered the benchmark overnight rate to a half-century low of 1 percent and kept it there.  On the other hand, if the economy continues to slide, the Bernanke Fed will face criticism for not moving aggressively enough.

For all its collective wisdom and analytical tools, the Fed has no way of knowing which way the economy will turn in the coming months, said Lee Hoskins, former Cleveland Fed president.

“Economists in general — including Fed economists — are terrible at calling turning points,” he said. “They’re very bad forecasters at that point in time.”

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