Fed's Poole - More rate cuts to be made if needed

He was delivering prepared remarks in the form of a lecture to The Institute of Governmental Affairs at the University of California, Davis, Thursday 18 October.

Noting that most analysts expect U.S. gross domestic product to decline in the third quarter, he added that "some talk as though" a successive contraction in the fourth quarter is a "certain" outcome. "It is not," Poole said.

"We should not be surprised if that is the outcome, but neither should we be surprised if the fourth quarter shows positive growth," he said.

Noting that most forecasts for the likely prospects of the U.S. economy during the next six to 12 months "are spread across a range from modestly poor to modestly good" and adding that the terrorist attacks of 11 September "have hurt the aggregate economy over the near-term," he emphasized the economy's strengths as much as its weaknesses.

Strong points include expectations the rate of inflation should remain low, "resilient people who are not going to sit back and watch the situation deteriorate," and the role of the Federal Reserve in the aftermath of 11 September in "keeping the mechanics of the payments system in good order." In addition, the U.S. banking system is strongly capitalized, unlike in August 1990 when the Gulf War broke out, he said.

Another factor in the economy's favor is that "A substantial amount of monetary and fiscal policy stimulus was already in place before 11 September; additional monetary stimulus is in place now and more fiscal stimulus is in the works," Poole said.

On the other hand, these factors may equally well not make fourth quarter GDP expand, after the shrinkage that most analysts expect in the third. Two successive quarters of contraction would meet the textbook definition of a recession.

The Federal Reserve will watch incoming economic data carefully, Poole said.

"If necessary, more monetary policy ease will be put in place," he said, but warned that "as data arrive suggesting revival of growth, we'll have to watch to be sure that we are not observing a false dawn." He added, "We'll also have to be careful not to overstay policy ease."

Poole, a voting member of the policy-setting Federal Open Market Committee, is viewed by many as one of the more hawkish members of the Fed on inflation.

Over the long run, the "prospects for the U.S. economy remain basically unaffected," Poole said. "The dynamic nature of the economy has not been damaged," he added.

He also made reference to the Fed's actions to provide huge amounts of extra liquidity to the financial system in the days immediately following 11 September.

"In the absence of Fed intervention" to add liquidity to the banking system, "we would have seen a cascade of defaults as firms due funds that were not arriving would be unable to meet their obligations. This default cascade would have spread the problem throughout the world economic system," he said.

The Fed avoided this scenario by making loans through the discount window to depository institutions, making a large increase in the Federal Reserve float and undertaking much bigger than usual open market operations with repurchase agreements, and outright purchases of securities.

In addition, "a modest amount of extra cash" was shipped to banks requesting it, helping automatic teller machines or ATMs to function normally.

Click the link on the top right to read the speech by William Poole.