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More rate cuts hinted

The Baltimore Sun

WASHINGTON -- Federal Reserve Chairman Ben S. Bernanke, worried about growing unemployment and financial jitters, said yesterday that the economy may need a boost from "substantive" cuts in interest rates.

That left investors speculating on whether "substantive," defined by Webster's as meaning "of considerable amount," suggests the Fed will lower short-term interest rates by a quarter of a percentage point, or by a half.

Initially, stock prices rocketed up on hopes for a big rate cut at the Fed's next meeting Jan. 29-30. But then they receded as investors reconsidered what Bernanke might have meant in his speech to a joint luncheon in Washington of two groups, Women in Housing and Finance, and the Exchequer Club.

By the close of trading, stocks were back up, with the Dow Jones industrial average rising 117.78 to 12,853.09, as most people concluded Bernanke was indeed signaling a rate cut of half a percentage point this month.

"The outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced," Bernanke said. That means lower interest rates "may well be necessary."

Since September, the Fed's Open Market Committee has cut its benchmark federal funds rate from 5.25 percent down to 4.25 percent.

Despite that big drop, the Fed's policymakers "stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks," Bernanke said.

The Fed has been trying to figure out which is the bigger risk: inflation or recession.

If the central bank cuts interest rates too much, it could overstimulate the economy, driving up demand for oil, gasoline and other already-expensive commodities. Low interest rates also weaken the U.S. dollar and make imported goods more costly for consumers.

But if the Fed fails to cut interest rates enough, it could allow the economy to slide into recession.

The Fed chairman said he is worried about rapidly rising food and fuel prices. If people start to think the Fed is afraid to raise interest rates to restrain price spirals, then "the Fed's inflation-fighting credibility" would be eroded, he said.

Nonetheless, the Fed must try to ward off a recession, he said. Just last month, the unemployment rate jumped to 5 percent, up from 4.7 percent in November. Bernanke called that development "disappointing."

Until December, "the labor market has been a source of stability" for the economy, providing "relatively steady gains in wage and salary income," he said. If the labor market keeps worsening, "the risks to consumer spending would rise," Bernanke said.

He also said "the demand for housing seems to have weakened further."

When you put it all together, the outlook might prove unsettling for the average American, he explained. "A number of factors, including higher oil prices, lower equity prices, and softening home values, seem likely to weigh on consumer spending as we move into 2008," he said.

Bernanke also worries about banks because "the financial situation remains fragile, and many funding markets remain impaired."

Meanwhile, both the Bush administration and Democrats are talking about possible steps government could take to stimulate the economy.

Top economists met yesterday at the Brookings Institution, a think tank, to discuss proposals. Mark Zandi, chief economist at Moody', said Congress should extend unemployment insurance while the economy goes through this tough time.

But Martin Feldstein, a professor at Harvard University, said it would be better to offer a tax rebate to "put cash into people's pockets that they will spend."

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