Fed should be ready to go to zero
Bernanke says deflation unlikely, low inflation probable
By Corbett B. Daly, CBS Marketwatch
Last Update: 12:23 PM ET July 23, 2003
WASHINGTON (CBS.MW) -- The Federal Reserve should stand ready to cut overnight lending rates to zero if the economy needs an extra jolt, said a Fed governor on Wednesday.
"We should be willing to cut the funds rate to zero, should that prove necessary to provide the required support to the economy," Federal Reserve Board Gov. Ben Bernanke said in a speech at the University of California, San Diego. A copy of the speech was released in Washington.
His remarks helped propel bond prices higher.
Following the speech, a benchmark 10-year note rose 14/32 at 96 14/32. Its yield ($TNX: news, chart, profile) fell to 4.07 percent from 4.15 percent in the previous session. The 10-year struck a seven-month yield high at 4.21 percent Monday after falling to a 1958 low 3.07 percent in mid-June.
And the U.S. dollar extended its broad decline after the speech. Euro/dollar was recently up 1.1 percent at $1.1450. Euro/yen improved 0.9 percent at 135.95. Sterling/dollar rose 0.8 percent at $1.6086.
It was Bernanke's speech in November last year that helped fuel a huge rally in the bond market on the notion the Fed might take the unconventional step of buying Treasury securities to hold down borrowing costs.
The policymaking committee's point man on deflation said the risk of further declines in inflation from an already low level outweighs the risk of a resurgence in inflation.
"We are currently in a range where undershooting our inflation objective by 1 percentage point is more costly than overshooting by 1 percentage point," he said.
"Hence, monetary ease appears to be indicated for a considerable period," Bernanke said, adding "keeping the funds rate target at or near its current level for an extended period may be sufficient."
The Fed cut the key federal funds rate target by a quarter point to a 45-year low of 1.0 percent on June 25 in an effort to boost the economy and encourage a bit of inflation.
Bernanke said that because of substantial amounts of excess capacity in the economy, the Fed should be mindful of continued low inflation.
"Even if the economy recovers smartly for the rest of this year and next, the ongoing slack in the economy may still lead to continuing disinflation," Bernanke said, adding "stable expectations of inflation and the recent weakening of the dollar may help to offset that tendency."
Bernanke said he sees the core rate of inflation falling to 0.7 percent, from the current 1.2 percent, by the end of next year.
Bernanke said that the Fed should be more worried about slowly rising prices than falling prices.
"Inflation in the range of 0.5 percent per year in the United States in the couple of years, though relatively unlikely, is considerably more likely than deflation of 0.5 percent per year," Bernanke said.
The remarks indicate that the Fed is in a holding pattern before deciding what its next move will be, said economist Drew Matus of Lehman Brothers in New York.
"This speech simply confirms that the Fed has a broader tolerance range in regards to economic developments than it has had in the past," said Matus.
Bernanke again alluded to the possibility that the central bank might use non-traditional methods to stimulate the economy by keeping long-term interest rates low.
"Such measures might include, among others, increased purchases of longer-term government bonds by the Fed, an announced program of oversupplying bank reserves, term lending through the discount window at very low rates, and the issuance of options to borrow from the Fed at low rates," Bernanke said.
The Fed governor said he expects the nation's unemployment rate to remain at the current 6.4 percent and then fall to 6.0 percent by the end of next year.
Corbett B. Daly covers politics and the economy for CBS MarketWatch in Washington.
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LOL!
As the last quarter point drop in the Fed Funds was succeeded by a full basis point elevation in long rates...
Why will the market follow if the Fed Funds Rate goes negative?
As we approach the Zero Funds Rate Event Horizon, has the market already called the Fed's "unconventional" bluff?
I believe so.
The resultant ramifications of monetizing debt, which when begun, would be required in perpetuity at progressively grater rates of application, like a narcotic fix, would so distort markets, that a structural buckling would be imminent. |
