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Fed In Holding Pattern

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CBS/AP
The Federal Reserve voted Wednesday to keep interest rates at their current 41-year low, with war hanging over the economy and few signs that a recovery has taken hold.

In explaining the unanimous vote, the Fed's Open Market Policy Committee gave reason to hope.

"Signs that weakness in demand is abating and economic activity is beginning to firm have become more prevalent," the Fed said. "With the forces restraining the economy starting to diminish, and with the long-term prospects for productivity growth remaining favorable and monetary policy accommodative, the outlook for economic recovery has become more promising."

But the Fed warned that "the degree of any strength in business capital and household spending … is still uncertain" and maintained its pessimistic policy outlook: that "the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future."

Leaving borrowing costs low might motivate consumers to keep on spending and businesses to step up investment during these muddled economic times, something that would bolster economic growth, economists say.

The economy has been struggling mightily to get back to sure footing after being pummeled by the 2001 recession. It grew at a respectable 4 percent rate in the third quarter of 2002, but probably slowed sharply in the final three months of last year.

Consumers, whose spending accounts for two-thirds of all economic activity in the United States, have been keeping the economy going. Low mortgage rates have powered sales of both new homes and previously owned homes to record highs in 2002.

But economists are keeping a close eye on consumers' behavior. The Conference Board's Consumer Confidence Index fell in January for the second straight month, weighed down by worries about a war.

Economists say the economy needs a sustained turnaround in business investment. Businesses, worried about a possible war with Iraq and other uncertainties, have been in no mood to go on hiring sprees or buying binges when it comes to capital investments in plant and equipment.

"Iraq is the biggest risk to the economy," said Lynn Reaser, chief economist at Bank of America Capital Management.

The nation's unemployment rate stands at 6 percent and economists believe it could creep higher in the months ahead as the U.S. continues what looks like a "jobless recovery."

Productivity gains in recent years will actually contribute to this problem, because many firms can meet rising demand without hiring, but simply working existing employees harder.

Against this backdrop, many economists expected Fed Chairman Alan Greenspan and his colleagues to hold the federal funds rate steady. The funds rate is the interest that banks charge each other on overnight loans and is the Fed's main lever for influencing the economy.

The Fed lowered interest rates 12 times starting in January 2001, with the last rate cut coming in November 2002, the only rate reduction of that year. Economists said it takes time for the full power of all of those rate reductions to show up in the economy.

The Fed is reluctant to cut rates further because rates are so low that any reduction would leave very little room to respond to a sudden, severe shock to the economy, like another terrorist attack or a drawn-out war in the Middle East.

With the aim of energizing the economy, President Bush has offered a 10-year, $674 billion tax-cut proposal.

Published reports say that at a private briefing for senators last week, Greenspan did not support the president's plan, saying that it would provide little short-term stimulus to consumer spending.

There are also worries higher deficits, which necessitate government borrowing, will push interest rates up. That would counteract the Fed's rate cuts.