April 9, 2008 | last updated May 26, 2012 4:00 am

Fed minutes show talk of 'prolonged' downturn

Federal Reserve officials raised the specter of a "prolonged and severe economic downturn" during a mid-March meeting at which they voted to slash a key interest rate to stabilize U.S. business and consumer activity.

The minutes of the March 18 meeting, released Tuesday, illustrate the stark situation facing Fed Chairman Ben Bernanke and his colleagues, including what appears to be a growing consensus at the central bank that recession is likely.

Fed staff presented a new, dour forecast showing the economy contracting in the first half of 2008, then slowly rebounding. The staff also raised its inflation outlook, however, given rising energy and commodity prices.

"Many (Fed members) thought some contraction in economic activity in the first half of 2008 now appeared likely," the minutes say. "Some participants expressed concern that falling house prices and stresses in financial markets could lead to a more severe and protracted downturn" than anticipated.

The Fed, in a series of historic moves, has tried to buoy the markets and broader economy by cutting the key federal funds rate to 2.25 percent from 5.25 percent last September. That includes a three-quarter-point cut at the March 18 meeting. The rate is a benchmark for many business and consumer loans.

Further, the Fed has offered low-interest loans to commercial banks. And just days before the March meeting, the Fed invoked Depression-era authority to lend to investment banks as it swooped in to broker the sale of Bear Stearns to JPMorgan Chase to prevent a financial market meltdown.

Despite the efforts, conditions remain strained. The minutes say that one of the Fed's big fears, a so-called adverse feedback loop, has materialized. Under such a scenario, a credit crunch hurts the broad economy, which prompts lenders to pull back even more.

Several Fed officials said "declining asset values, credit losses and strained financial market conditions could be quite persistent" with potential to "delay and damp economic recovery."

Still, inflation concerns trumped economic worries for two officials - Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher. Both voted against the rate move, favoring a smaller cut. Plosser warned in the minutes that if Fed waited too long, it would be difficult to rein inflation.

A number of economists expect the Fed to slow down the pace of rate cuts, with Harm Bandholz of UniCredit expecting two cuts of a quarter point each at coming Fed meetings. But given the level of concern in the minutes, a few more ugly pieces of data such as last Friday's report that employers shed 80,000 jobs in March, "may prompt the Fed to cut rates even more," he said.

The minutes underscore the need for additional efforts to shore up the housing market, where prices are plummeting. Some stabilization is needed to shore up an economic recovery ahead though there was "little indication" that had begun.

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