Richard Whalen

Federal Reserve Chairman Ben Bernanke did not mince any words in his February 14th testimony to Congress: “The outlook for the economy has worsened….and downside risks to growth have increased.”

But the Fed Chairman is playing catch-up. I reported clear recession signs in November. Why didn’t Bernanke see it? Under rising criticism for not acting quickly enough to ease policy, Bernanke promised Congress that the Fed would act “in a timely manner as needed to support growth.” The Fed has reduced its benchmark interest rate, called the federal funds rate, five times since September, including two cuts within eight days last month. The rate has fallen to 3 percent; as recently as late summer of last year it was 5.25 percent.

Veteran Fed-watchers share my view that a recession has begun and more rate cuts are coming. I believe we will see a Fed funds rate of only 2 percent by spring. Consumer inflation was at 4.1 percent in January, but was believed to be slowing by the same Fed analysts who missed the recession signs.

With inflation in the 3 percent or higher range, anticipated further Fed easing steps would qualify as “emergency” rate reductions, restoring the real (inflation adjusted) “zero” rate level from mid-2003 to mid-2004 during the Alan Greenspan era. In effect, with a “zero” real Fed funds rate, lenders give borrowers “free money” -- a recipe for creating more inflation and another speculative bubble.

Belatedly, Greenspan now warns that the risk of a 2008 recession is 50-50. The economy’s decline is already gaining momentum. In January, the government’s index of payroll employment fell by 17,000 jobs. The service sector, the main engine of economic growth, is weakening. The Institute for Supply Management’s index of non-manufacturing activity fell sharply in January.

The Fed cannot revive growth simply by making quick rate cuts. The economy’s credit system has broken down. With bad real estate loans mounting and their capital at risk, banks are increasingly reluctant to make loans. Lenders are imposing tougher terms and conditions on would-be borrowers. Tighter credit strangles business activity and industrial expansion, and kills jobs. Unemployment is poised to jump by mid-year.

As the jobless rate rises this year while interest rates fall, the Fed will be a study in futility – pushing on a string. Cheaper money fuels Wall Street but does not stimulate long-term investment and job creation. The once unthinkable has arrived: an election-year recession.