Fed enters key meeting with no clear path

In one worrisome sign, government data showed that the unemployment rate jumped to 5 percent last month from 4.7 percent in November. The Fed won’t get another look at the job picture until Friday, when figures for January will be available. Some economists note that weekly tallies of new filings for unemployment have been falling recently, a sign that the job market may be holding up fairly well.

In the meantime, skyrocketing consumer prices have kept the Fed on alert to a potential outbreak of inflation, which at 4 percent last year was about double the Fed’s target. Cutting rates too sharply could add upward pressure on prices.

“It looks like oil is going to come off this year, and food prices are going to ease up a little bit,  so maybe the Fed will get a break,” said Hoskins. “But they’re still going to end up with an average inflation rate that — from my point of view — is way too high.”

The futures market is betting the Fed will cut at least another quarter-point and maybe a half-point when the meeting concludes Wednesday. 

Still, while the Fed may have rushed to put out the past week’s fire in the global stock market, central bankers don’t like to appear to be setting rates based on what investors are saying or doing.

“Wall Street is greedy,” said Rivlin. “Wall Street will never be satisfied. They’d like interest rates at minus 10.”

It’s also not clear that lowering short-term rates will have much impact on the main source of the economy’s weakness: a housing recession that followed a price bubble.

Despite falling interest rates and some $100 billion in cash pumped into the global banking system by the Fed, credit remains tight as lenders worry about the risk of further losses from bad mortgage debts. Unless the tide can be turned to stop a coming wave of mortgage foreclosures, rising loan defaults this year will dump more empty houses on a market already glutted with too many listings. So far, tumbling mortgage rates have done little to revive the housing market.

“Right now, they won’t — because we’ve built too many houses,” said Rivlin. “We have an overhang of excess supply, and there’s no way that lowering interest rates is going to rev up home construction for quite awhile.”

Sales of new homes fell last year to their lowest levels on record, forcing homebuilders to cut back further and taking a big bite out of spending on home furnishings, appliances and other new home purchases.

Lenders are working to help borrowers who are headed for trouble by refinancing some loans at lowers rates. Congress may help with a move to lift the caps on government-backed loans written by Freddie Mac and Fannie Mae.

But in the long run, there are limits to how far these measures can help those homeowners who got in over their heads — and lenders who simply made bad loans. Hoskins said the Fed can cut rates all it wants, but that won’t solve what he calls an “insolvency” problem.

“A lot of homeowners are going to be insolvent," said Hoskins. "In other words they’re going to lose their homes, and maybe some financial institutions are going to be insolvent. The Fed can pump in a lot of liquidity, but all that does is allow the insolvents to survive a little longer. They’re just delaying the adjustment process.”

Former Fed officials also say that investors and the public may be overestimating just how much the central bank can do to revive a flagging U.S. economy — especially when the weakness is coming from specific regions or sectors like housing.

“The Fed clearly doesn’t have a rifle to deal with problems, it has more like a shotgun,” said Parry. “I think it’s very important to realize that the Fed has limited ammunition to deal with problems in particular part geographic areas or, for that matter, particular industries.”

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