December 4, 2008 / 4:23 PM / 10 years ago

UPDATE 2-Fed's Evans: economy getting worse, needs action

(Incorporates comments from Q&A)

By Ros Krasny

DEARBORN, Mich., Dec 4 (Reuters) - The year-long U.S. recession has taken a turn for the worse in the past six weeks, forcing policy-makers to consider all options to engineer a turnaround, a top Federal Reserve policy-maker said on Thursday.

Chicago Federal Reserve Bank President Charles Evans said that the economy is “contracting markedly” as consumer spending sinks and the jobless rate rises, and that a recovery might not be on tap until 2010.

“The outlook has clearly deteriorated” in the past six weeks, Evans told reporters after a speech to the Michigan Bankers Association in Dearborn, Mich., a suburb of Detroit.

“The incoming data, particularly on consumer spending and labor market conditions, have been weaker than I expected,” Evans said. “We need to make policies appropriately accommodative. We will be thinking very broadly.”

The Federal Open Market Committee has already dropped its benchmark lending rate to 1 percent from 5.25 percent since September 2007 in an attempt to stabilize financial markets and stem economic weakness.

Financial dealers anticipate at least a half percentage point cut in the Fed’s benchmark lending rate at the Dec 15-16 policy meeting, to 0.5 percent, with a strong chance the rate will be cut to 0.25 percent.

A chorus of Fed watchers expect the FOMC to lower fed funds to zero by January, and to expand quantitative measures to pump more liquidity into markets, echoing efforts by Japan’s central bank to revive that country’s economy in the 1990s.

Evans said the Fed is already engaging in a form of quantitative easing, and “will use all weapons in its arsenal” to stabilize financial markets and support the economy.

Evans is not a voting member of the Federal Open Market Committee in 2008 but will vote in 2009.

ASSUMPTIONS CHALLENGED

The National Bureau of Economic Research, official arbiter of U.S. economic cycles, said this week that the economy fell into recession in December 2007, making it already the third-longest since the Great Depression of the 1930s.

Evans said the current episode challenges prevailing notions that modern recessions will be shorter because of the central bank’s ability to smooth out peaks and valleys in the business cycle.

“It is very difficult to judge how long the downturn might last and how deep it ultimately will be,” he said.

“We could see activity remaining quite sluggish through much of 2009,” before a recovery gains a foothold in 2010 and 2011, Evans said.

The decline in consumer spending over the past few months has been on par with the drops seen during the 1990 and 1982 recessions, he said. Business investment and industrial production are also seeing “marked weakness.”

DISINFLATION, NOT DEFLATION

Substantial slack in the economy from a rising jobless rate, along with the notable decline in energy and commodity prices, should bring down inflation, Evans said.

Core prices have been falling faster than expected since their peak in the summer, Evans said.

He added that he now expects disinflation, or decline in the inflation rate, not deflation, or a persistent, damaging decrease in the general level of prices.

“I’m certainly not calling for deflation,” Evans told reporters.

The total personal consumption expenditures (PCE) price index should fall to between 1.4 and 1.7 percent in 2011, he said. “To me, this outcome would be consistent with price stability.”

THE ROAD AHEAD

Evans said financial markets have shown signs of healing from the credit crisis that erupted in August 2007, but it would be “a while” before markets function in a smooth, efficient manner.

“Financial distress is still evident,” he said.

President-elect Barack Obama has “surrounded himself with very smart economic advisors,” Evans said in answer to an audience question.

“I’m very impressed with Tim Geithner,” the New York Fed president that Obama named for Treasury Secretary.

Evans declined to comment specifically about the auto industry, a major component of the Chicago Fed District’s economy. Leaders from Detroit’s “big three” automakers pleaded their case before Congress for emergency cash to stave off possible bankruptcy,

“There are very real business-cycle challenges” facing automakers, he said, noting the collapse in total U.S. car and truck sales that has accompanied the recession.

It will be a “better outcome” if the resources and skills evident in the auto industry do not disappear, Evans said. (Editing by Tom Hals)

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