Plosser Says Fed Rate Cut Not Always Needed to Soothe Markets

Sept. 9

Federal Reserve Bank of Philadelphia President Charles Plosser said there is an ``underlying stability'' in the U.S. economy and officials need not always cut interest rates in response to turmoil in financial markets.

``Disruptions in financial markets can be addressed using the tools available to the Federal Reserve without necessarily having to make a shift in the overall direction of monetary policy,'' Plosser said yesterday at a conference in Waikoloa, Hawaii.

Plosser said while the housing slump has lowered forecasts for the expansion and there is ``considerable uncertainty'' about the outlook, he expects economic growth to return ``toward trend later in 2008.'' The drag from housing will ``gradually'' ease, concluding sometime next year.

The comments suggest that Plosser has yet to conclude a reduction in the Fed's benchmark rate is critical to safeguard the economy, which lost jobs for the first time in four years in August. The Philadelphia Fed chief doesn't vote on the rate- setting Federal Open Market Committee until next year.

Lowering the benchmark rate is an ``option if financial sector problems spill over to significantly harm the outlook for the broader economy,'' said Plosser, 58, who took office a year ago. And, when shocks threaten market stability, a central bank ``must be prepared to act promptly,'' he said.

Plosser said that the U.S. has coped with blows in the past, such as the devastation of Hurricane Katrina in 2005 and oil- price shocks, and that a decline in one industry ``does not always imply major problems in the economy as a whole.''

Economy's `Stability'

``It is important to understand and appreciate this underlying stability of the economy in the face of temporary disturbances as we seek to assess monetary policy,'' Plosser told the Pennsylvania Association of Community Bankers convention.

Investors and economists said Sept. 7 there's little doubt Fed policy makers will lower the main rate after a government report that day showed employers unexpectedly cut 4,000 from payrolls in August. The FOMC meets on Sept. 18 and interest-rate futures indicate it will lower the target rate for overnight loans between banks by at least a quarter point from 5.25 percent.

``The Committee usually does not base its decision to change monetary policy on any one number,'' Plosser said, without referring specifically to the August jobs report.

Answering questions following his speech, Plosser said the outlook for inflation is ``still up in the air,'' and it's not clear that the moderation in prices of recent months will be sustained.

Still a `Stigma'

Plosser noted that the Fed has already taken several steps to ease stress in financial markets, including injecting cash into the system and cutting the rate for direct loans to banks. There's still a ``stigma'' attached to borrowing from the Fed's discount window, and the central bank is working to improve the situation, he said.

The Philadelphia Fed president said the Fed's goal is to help markets operate in an orderly manner, and not to insure individuals or firms from losses or failures. That echoes other officials' concern about refraining from a bailout for investors who made bets that went bad.

``Providing liquidity does not necessarily require a more fundamental change in the direction of monetary policy as implemented by a change in the fed funds rate target,'' he said. In 1999, the Fed added cash to the banking system before the 2000 changeover without cutting rates, Plosser noted.

Officials' Remarks

A day before the employment report, four Fed district bank chiefs in separate remarks declined to endorse a rate cut.

Kansas City Fed President Thomas Hoenig and Dennis Lockhart of the Atlanta Fed said they hadn't seen sure signs of a housing spillover into the broader economy. St. Louis Fed President William Poole and the Dallas Fed's Richard Fisher said the effects of the turmoil so far were unclear.

Chairman Ben S. Bernanke said in an Aug. 31 speech that the Fed ``will act as needed'' to protect the wider economy from the credit-market rout.

Plosser said July 11 in a London speech that he agreed with many economists that growth would pick up to 2 percent to 3 percent this year. At the time, he said declines in homebuilding and house prices had ``so far not derailed the prospect that economic growth will return toward trend at the end of 2007 and in 2008.''

Many economists estimate the U.S. economy's trend rate of growth at close to 3 percent.


From: Bloomberg.com


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