SEATTLE, Nov 16: Federal Reserve Bank of San Francisco President Robert Parry on Thursday offered one of the central bank’s most sober assessments of the economy, saying the outlook was rocky and there was room for more interest rate cuts if needed.
Parry said the short-term outlook is grim, although long-term prospects remain good. A decline in output in the fourth quarter may well be worse than the 0.4 per cent fall in third-quarter gross domestic product and that contraction could extend into the first quarter of next year or even beyond.
If it’s necessary to reduce rates, I don’t see any constraints on the Fed at this point, Parry told reporters after addressing the University of Washington business school. If further action is required, I am sure we have the capability to do that.
A recovery is likely sometime next year but it is impossible to say when, Parry added.
Asked if the Fed would be reluctant to let the benchmark federal funds rate on overnight bank lending fall below the rate of inflation, creating negative real interest rates, Parry said such a situation “is not all that bad” when output is declining.
The Fed slashed the funds rate for the 10th time this year earlier this month, bringing it down to 2.0 per cent, the lowest level in four decades. The rate has been lowered by a total of 4.5 percentage points since January.
Parry said there were various opinions within the Fed over which inflation measure should be used to calculate real interest rates and said he was not sure which would be best.
Using the Consumer Price Index, which currently shows about a 2.6 per cent annual rate of inflation, would put real interest rates already below zero. Alternative measures of inflation, such as the GDP implicit deflator, are running at lower rates than the CPI.
Even if the nominal fed funds rate fell to zero, the Fed could continue to pump money into the system by adding bank reserves, Parry said.
You can just give people money, whether you spread it from helicopters or whatever it is, he said, adding that such an approach would not affect interest rates but could stimulate spending.
I think we still have ammunition in the US and I don’t see the US running out of it, said Parry, who is currently a non-voting member of the central bank’s policy-setting Federal Open Market Committee.
Giving a grim assessment of the US economy, Parry said the immediate future for the economy was bleak because of uncertainty following the Sept 11, attacks on the United States.
Until Sept 11, consumer spending had been keeping the economy afloat. But the attacks undermined confidence and spending, the main pillar of economic support.
Parry predicted the unemployment rate would rise further, after spiking in October to 5.4 per cent from 4.9 per cent, noting that industrial output and business investment are still are dropping sharply.
But aggressive rate cuts, massive fiscal stimulus which Parry said could total $160 billion in fiscal year 2002 and falling oil prices are laying the foundation for a rebound.
When will the recovery kick in? Most likely sometime next year. But frankly, there is no way to know exactly when, said Parry.
He said the spread of economic weakness around the world is one of the wild cards in the outlook. Indeed, the International Monetary Fund on Thursday revised downward its global outlook, forecasting growth below the critical 2.5 per cent level which signals recession this year and next.—Reuters
