Bernanke: Fed Could Cut Rates to Zero

Governor says central bank would take borrowing costs lower, use other methods to spur growth.

July 23, 2003

LA JOLLA, Calif. (Reuters) - Federal Reserve Governor Ben Bernanke said on Wednesday that the central bank would be prepared to cut interest rates all the way to zero if necessary to prevent a fall in inflation.

Treasury Secretary John Snow tells Lou Dobbs that the economy is on track for stronger growth during the second half of this year.

Speaking to a university audience, Bernanke said if the Fed were to reduce overnight borrowing costs to zero, it would look at so-called nontraditional methods of trying to spur growth, such as buying long-term bonds.

He expressed confidence that those methods would work if the Fed needed to turn to them. But policymakers still appear focused on using their central tool of controlling short-term interest rates for now.

"Monetary ease appears to be indicated for a considerable period," Bernanke said. "Keeping the federal funds target at or near its current level may be sufficient.

"Alternatively, as Chairman (Alan) Greenspan testified last week, we could certainly cut the rate from where it is now," he told the Economics Roundtable of the University of California at San Diego.

During a question-and-answer period, Bernanke again said he considered the Fed has room to keep trimming the federal funds rate, which is charged on overnight loans between banks, from its current 45-year low of 1 percent.

"We're not done yet," he said. Fed policymakers reduced the fed funds rate a quarter percentage point on June 25, citing concern about the economic risks from a further fall in inflation, and are next scheduled to meet on Aug. 12.

The dollar sank in value on currency markets following Bernanke's comments, apparently fearful that cheaper credit makes the currency less attractive, while bond prices rallied as investors looked for a safer haven.

Bernanke said he personally did not foresee "a drastic change" in the inflation rate and said he considered deflation a "remote" possibility. "Should further declines occur, a more gradual downward drift over a period of one to two years would be the more likely scenario, " he said.

Bernanke also said he was well aware that reducing short-term interest rates closer to zero would carry some cost, including reducing interest income for savers like senior citizens and eroding profits in money markets.

But, he emphasized, "We should be willing to cut the funds rate to zero, should that prove necessary to provide the required support to the economy."

He made clear that preventing a further slowing in inflation -- or outright deflation in which widespread price declines set in -- must be a priority for Fed policymakers.

"I hope we can agree that a substantial fall in inflation at this stage has the potential to interfere with the ongoing U.S. recovery," Bernanke said.

He said that while the risk of deflation was "remote," it could do "significant economic harm" if it were set loose. Deflation, which has not been seen in the U.S. economy on a sustained basis since the 1930s, erodes asset values and could destabilize the nation's financial system.

Bernanke said there were some factors helping to counter a trend toward softening prices, including a falling value for the dollar that raises prices for imported goods and the fact that most consumers still anticipate modest increases rather than decreases in prices ahead.

http://money.cnn.com/2003/07/23/news/economy/fed_bernanke.reut/index.htm