A tribute to GATA and its chairman, Bill Murphy

Section:

But of course there couldn't possibly be
anything like a Plunge Protection Team!

By MARTIN CRUTSINGER
Associated Press Economics Writer
April 7, 2003

WASHINGTON (AP) -- Confronting new fears of recession, the
Federal Reserve is refining an emergency economic rescue
plan that includes further interest rate cuts and billions of
dollars in extra cash for the banking system.

The Fed's effort would be aimed at pulling the country out
of a nosedive that has seen 465,000 jobs evaporate in just
the past two months, raising fears among economists that
the weak recovery from the 2001 recession is in danger of
stalling out altogether.

"Clearly, the Fed is in uncharted territory," said economist
David Jones. "I think they will try some experimental moves."

One key element of the plan Fed officials are considering
hasn't been used successfully in a half-century.

Based on comments by Federal Reserve Chairman Alan
Greenspan and other Fed officials, the central bank is
signaling that it is poised to move beyond its traditional
buying and selling of short-term Treasury securities to the
direct purchase of longer-term securities in an effort to pump
more money into the banking system and influence long-term
interest rates.

Also, Fed officials have indicated they are prepared in the
event of an unexpected shock to the system to lend massive
amounts of money directly to commercial banks to make sure
that financial markets do not freeze up.

And as a third policy option, Fed officials have indicated they
would explicitly state that if the federal funds rate is moved
below its current 41-year low of 1.25 percent, it is likely to
stay at the lower level as long as needed to get the economy
on its feet -- which would help ease investors' worries about
a sudden jump in interest rates down the road.

The fact that Fed officials have been so open in discussing
these options underscores the need the central bank sees
to restore investor confidence that has been shaken by the
fact that the Fed's aggressive two-year campaign to cut
short-term rates has yet to produce a sustainable economic
recovery. The Fed's target for the federal funds rate, the
interest that banks charge for overnight loans, is now at a
41-year low of 1.25 percent.

"The Fed is trying to buck up fragile confidence," said Mark
Zandi, chief economist at Economy.com. "They know that
everyone is asking the question: What can be done if the

U.S. economy slides back into a recession and it ignites a
deflationary cycle?"

Greenspan in a speech in December in New York noted that
the Fed from 1942 to 1951, as part of an agreement with the
White House, successfully capped long-term Treasury yields
at 2.5 percent as a way to hold down borrowing costs to
finance World War II.

However, private economists note that a later Fed effort
dubbed "Operation Twist" -- in which the central bank sold
short-term Treasury securities and bought long-term
securities in the early 1960s in an effort to influence rates
at both ends of the yield curve -- was judged to be a failure
because the central bank did not make the transactions in
large enough amounts.

"If you want to produce results, you have to convince markets
that you are serious and will do whatever it takes to alter the
rate structure," said former Fed board member Lyle Gramley.

The Fed made just such a massive response on Sept. 12,
2001, the day after the terrorist attacks, when it lent a record
$46 billion to banks in a single day to keep the financial
system functioning.

Fed officials have indicated that their battle plan has been
influenced heavily by reviewing the mistakes made by the
Bank of Japan, which has been unable to jump-start that
country's economy over a decade despite driving short-term
interest rates to zero. Fed officials believe the Bank of
Japan's biggest mistake was being slow to respond after that
country's real estate bubble burst in the late 1980s.

Vincent Reinhart, the Fed's top monetary policy staffer, told
an economic conference recently that the Fed is striving to
act pre-emptively before falling prices become entrenched.

"The best policy for dealing with deflation is to avoid it
strenuously by acting pre-emptively," he said.

Because of this, some economists believe the Fed will not
wait until its May 6 meeting to put its plan into effect,
opting to cut the federal funds rate through an emergency
conference call, possibly as soon as this week.

However, other analysts argue that the Fed will likely wait,
hoping that U.S. advances in the war against Iraq will bolster
markets in coming weeks and restore confidence. These
economists noted that Wall Street rallied Monday on the
news that U.S.-led troops had swept into Baghdad. The
Dow Jones industrial closed up 23.26 points after having
been up more than 243 points earlier in the day.

"The Fed is trying to say we are prepared and we are not
going to become another Japan," said Sung Won Sohn,
chief economist for Wells Fargo. But Sohn said if the war
continues to a swift conclusion and the economy responds
positively, the Fed will feel no need to cut rates further.