By Edward Kean Washington, June 15 (BridgeNews) - Directors at half of the Federal Reserve's 12 district banks wanted only a "modest" quarter percentage point reduction in the discount rate in mid-May because they felt the benefits of the Fed's prior interest rate cuts would soon be realized, according to Fed documents released Friday.
The minutes of the Fed meetings over the past year, at which discount rate changes were considered, show that the directors of six Fed banks felt only "modest stimulus was needed" in mid-May to deal with weak U.S. economic conditions "in light of recent rate cuts and the expectation that the results would soon begin to be felt."
The Fed actually cut its discount rate and its fed funds target by a half percentage point at its May 15 policy meeting. After the Fed ordered those reductions, private economists said it had acted on the requests of less than half of the system's 12 district banks. Private analysts said that suggests there was division at the Fed's May meeting on whether a half-point rate reduction actually was needed.
The minutes of the meetings held by the Fed governors to consider discount rate changes--separate from the policymaking meetings of the Federal Open Market Committee--suggest there was indeed such a division within the Fed system. According to minutes of a Fed board meeting on May 14, the Philadelphia, Boston, Cleveland, Atlanta, Kansas City and Dallas Fed banks requested a discount rate cut of a quarter percentage point.
Conversely, directors of the New York, Richmond, Chicago, St. Louis and San Francisco banks had requested a larger half-point drop in the discount rate. And the Minneapolis Fed had requested no change in the discount rate. The Fed banks seeking a half-point discount rate cut favored "aggressive action" because of ongoing economic weakness as demonstrated by soft manufacturing conditions, declines in consumer confidence and the sharp drop in April employment.
However, the Fed banks seeking a more modest quarter-point cut characterized the economic picture as "mixed," while acknowledging that near-term prospects for stronger growth were "questionable." "Some noted continued strength in the energy sector and an increase in personal consumption and income," the minutes said.
The Fed bank directors who wanted to keep rates unchanged felt it was too soon to gauge the consequences of the Fed's earlier aggressive interest rate reductions. They noted better-than-expected first-quarter growth data and progress made in adjusting inventories to sales. The discount rate is the rate Fed banks charge commercial banks in their district for borrowing short-term funds at the Fed's discount window.
The discount rate is largely symbolic as it tends to move in line with the federal funds rate, the rate commercial banks charge one another for overnight loans. The Fed influences the federal funds rate by changing the cost and availability of bank reserves. The Fed has cut both the fed funds target and the discount rate a surprising 250 basis points this year in a bid to counter the sharp slowdown in U.S. economic activity of recent months. The disclosure that several Fed banks wanted only a modest quarter-point discount rate cut in mid-May comes amid debate among private financial analysts over whether the Fed will trim rates by a quarter or a half point at its next policy meeting on June 26-27.
Most economists expect a modest quarter-point cut since the Fed has already slashed rates so aggressively this year and short-term rates have fallen to relatively low levels. Indeed, some Fed officials have cautioned lately that the Fed needs to avert cutting rates too much to avoid an inflation pickup as the economy recovers next year.
The minutes of another Fed discount rate meeting released Friday suggest that directors at several Fed banks were uneasy in mid-April about further interest rate declines, shortly before the Fed stunned financial markets with a half-point interest-rate reduction on April 18. According to minutes of a Fed board meeting two days earlier to consider discount rate changes, five Fed banks--Kansas City, St. Louis, Richmond, Philadelphia and Chicago--voted to keep the discount rate unchanged.
"Directors in favor of maintaining existing rates expressed concern about further reductions in light of the policy easings already effected this year," the minutes of the April 16 meeting stated. "Some thought another reduction now might increase anxiety about the economic outlook, and others thought it appropriate to wait for more data." The minutes also show that it was in early December of last year that Fed Chairman Alan Greenspan indicated to other Fed governors the need for a "heightened alertness" on upcoming economic data. The U.S. economy began to slow in mid-2000, but it was not until late in the year that the severity of the slowdown became apparent.
When the FOMC met on Dec. 19, only 4 of the 12 Fed banks, Cleveland, St. Louis, Dallas and San Francisco, requested a cut in the discount rate. The other 8 banks wanted to keep the discount rate unchanged. Directors at these banks expressed concern about tight labor markets, and significant increases in health care costs. But by late December, directors of 7 banks had requested a quarter-point reduction in the discount rate. And on Jan. 3, the Fed surprised financial markets with the first of its five half-point cuts in short-term interest rates this year.