Fed Signals More Action as Slump Drags On

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1 Dow Jones Reprints: This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool at the bottom of any article or visit See a sample reprint in PDF Order a reprint of this article now format. DECEMBER 2, 2008 Fed Signals More Action as Slump Drags On Recession Began a Year Ago, Making It Longest Since Early '80s, Panel Says; Bernanke Considers Rate Cuts, Bond Purchases By JON HILSENRATH and SUDEEP REDDY See Corrections & Amplifications below Federal Reserve Chairman Ben Bernanke laid out new steps the Fed might take to lift the economy, as the panel that monitors the U.S. business cycle said the nation has been in recession for a year -- the longest downturn in a quarter century The National Bureau of Economic Research said Monday that America entered recession in December Mr. (1 of 11)12/8/2008 4:31:03 AM

2 Bernanke flagged the likelihood of further relief for the sagging economy at a speech in Austin, Texas. More reductions in short-term interest rates are "certainly feasible," Mr. Bernanke said. But with the Fed's benchmark rate already at 1%, more cuts would bring the rate to near zero, prompting concern that the Fed would be out of recession-fighting ammunition. Mr. Bernanke sought to emphasize other steps the Fed might take to spur the economy. Those steps could include an unusual attempt to bring down long-term interest rates by purchasing Treasury notes and bonds, something the Fed hasn't done since the early 1950s. Lower long-term rates would help bring down mortgage costs and other borrowing costs for businesses and individuals. A flurry of bearish news, including a decline in a key manufacturing-activity index, helped push the Dow Jones Industrial Average down points Monday, or 7.7%, wiping out about half of last week's gains. It was the 12th-biggest single-day percentage drop and the fourth-sharpest point drop since the Dow was created in Mr. Bernanke's comments helped stir more buying of longer-term Treasury bonds, to which investors already (2 of 11)12/8/2008 4:31:03 AM

3 had been fleeing. The yield of the benchmark 10-year Treasury note, already at its lowest level in more than 31 years, fell further, to 2.719%. The onslaught of troubling economic news also raises the chances that Democrats will push for a stimulus package during a lame-duck session of Congress this month, and make it more likely that President-elect Barack Obama will increase the size of the government-spending program he is designing. After the November election, House Speaker Nancy Pelosi said she favored a stimulus package of between $60 billion and $100 billion this year, followed by another round of spending next year. "Economic activity appears to have downshifted in the wake of the deterioration in financial conditions in September," Mr. Bernanke said in his speech. He pointed to a litany of soft spots: in the job market, household finances, exports and financial markets. The news is not all dire. The unemployment rate, at 6.5%, is rising but still well shy of its 7.8% level after the recession or the double-digit levels of the early 1980s. Mr. Bernanke also noted that falling oil prices have been a relief to households. But even that bright spot is related to the weak economy, since the global downturn is sapping demand for energy. (3 of 11)12/8/2008 4:31:03 AM

4 Once financial markets manage to improve, the Fed chairman warned, "economic conditions will probably remain weak for a time." Rule of Thumb The conventional rule of thumb is that a recession is two consecutive quarters in which the nation's gross domestic product contracts. The NBER, however, doesn't follow that formula. To pinpoint broad declines in activity, it considers a wide range of indicators in addition to overall economic output -- including payroll employment, industrial production, inflation-adjusted income and business sales activity. "Many of these indicators, including monthly data on the largest component of GDP, consumption, have declined sharply in recent months," the NBER said in a statement. At 12 months and counting, the downturn is already longer than the last two recessions in 2001 and , both of which lasted eight months. If the current cycle persists past April, it would be the longest recession since the Great Depression. Downturns in the 1980s and 1970s lasted 16 months each. 'Fairly Bleak' "The economic outlook looks fairly bleak," said Harvard professor Jeffrey Frankel, who serves on the NBER's (4 of 11)12/8/2008 4:31:03 AM

5 recession-dating committee, but said he wasn't speaking for the committee. "Forecasts that the trough would be sometime in the middle of next year don't strike me as especially pessimistic given the current situation." In November, economists surveyed by WSJ.com projected the recession would persist through the first quarter of U.S. GDP declined slightly in the fourth quarter of 2007 and third quarter of this year -- but increases in between have complicated the NBER committee's decisions. A separate measure of output, known as gross domestic income, peaked in last year's third quarter but also fluctuated until this year's third-quarter decline. The NBER committee focused primarily on employment, as it did in 2001, to pinpoint the recession's starting month. The expansion that followed the 2001 recession lasted 73 months, the NBER said, making it the shortest expansion in a quarter century. That expansion ended in December 2007, when U.S. payrolls peaked; they have been declining at an accelerating pace throughout this year. "We wait until we're sure that it is a recession," said Stanford economist Robert Hall, chair of the NBER recession-dating committee. Mr. Hall said the committee (5 of 11)12/8/2008 4:31:03 AM

6 looks for "the depth, duration and dispersion" of the downturn before making a call. Severe Downturn New data underscored the severity of the current downturn. The Institute for Supply Management's November manufacturing index, released Monday, fell to its lowest level since The ISM's new orders index -- a forward-looking indicator -- hit its lowest level since 1980, reaching 27.9 from 32.2 in October. That measure has fallen below 30 only three times in 60 years. Meanwhile, construction spending posted a steeper-thanexpected drop in October, according to government figures. The November employment report, due for release Friday, is expected to show nonfarm payrolls dropped in excess of 300,000 with a further increase in the unemployment rate. Mr. Bernanke's comments set the stage for an important meeting of Fed policy makers in two weeks. The Fed's main lever to help an ailing economy -- short-term interest rates -- has already been pulled about as far as it can go. Pushing down long-term interest rates could spur business and consumer demand, Mr. Bernanke said. Many consumer and business loans are closely linked to (6 of 11)12/8/2008 4:31:03 AM

7 longer-term Treasury yields. During the 1940s, the Fed maintained a ceiling on longterm government bond yields at around 2.5%. It created ceilings on other government debt as well. It could bring down long-term rates now by purchasing Treasury bonds itself. A central bank has the capacity to effectively print money by injecting reserves into the banking system and could use the funds to buy securities like bonds. In normal times, this would be highly inflationary. But Mr. Bernanke noted that the recession is putting downward pressure on inflation now, which gives him flexibility to keep pressing with new measures to battle the recession. He also said the Fed would unwind its programs when the economy stabilizes, to help guard against inflation. The Fed has already taken a big step toward targeting long-term interest rates. Last week, it said it would buy up to $600 billion in debt issued or guaranteed by Fannie Mae, Freddie Mac, Ginnie Mae and Federal Home Loan Banks, all mortgage businesses with close tied to the government. Yields on debt tied to these firms have come down, a development that Mr. Bernanke said he found encouraging because it has helped to rein in mortgage (7 of 11)12/8/2008 4:31:03 AM

8 rates. Impact on Interest Rates Some Wall Street economists have argued that the Fed might also commit to keep short-term interest rates low for an extended period of time, something the central bank did in 2003 when it was worried about the weak economy. Such a move in theory could also bring down long-term interest rates. But Mr. Bernanke didn't raise it as an option in his speech. Some economists believe the move by the Fed in 2003 backfired and helped to spur the credit boom that is now unwinding. The Treasury Department could also take new steps. Treasury Secretary Henry Paulson said in an interview with The Wall Street Journal that he is "working really hard" to implement existing initiatives and develop new ones. Congress has authorized the Treasury to invest up to $700 billion to bolster financial institutions. Mr. Paulson has put nearly half of that sum to work. The NBER makes judgments only on recessions and expansions in the U.S., but much of the rest of the global economy is in recession by other standards. The 15- nation euro zone, whose economy is second in size only to the U.S.'s, contracted in both the second and third (8 of 11)12/8/2008 4:31:03 AM

9 quarters -- two-straight quarters of decline being the traditional definition of recession. Joellen Perry and Michael Phillips contributed to this article. Write to Jon Hilsenrath at and Sudeep Reddy at Corrections & Amplifications In the original "Weighing the Losses" graphic, the time increments under the Gross Domestic Product chart were incorrectly labeled as months. Copyright 2008 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at or visit (9 of 11)12/8/2008 4:31:03 AM

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Treasury Hones Next Rescue Tool

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