Federal Reserve chairman Ben Bernanke acknowledged yesterday that the economy has deteriorated rapidly and signaled the Fed will cut interest rates aggressively to avoid a recession.
Bernanke, speaking in Washington, joins a growing chorus of economists becoming more pessimistic about the economy. Over the past several days, many analysts have downgraded their outlooks, with a growing number forecasting recession, most notably economists at Wall Street investment bank, Goldman Sachs Group Inc.
The catalyst for increasing gloom was last week's employment report, which showed the US jobless rate jumping to 5 percent from 4.7 percent with hiring all but stalled in December. The nation added just 18,000 jobs last month. Excluding government hiring, payroll employment declined. Private employers shed 13,000 jobs last month, the Labor Department said.
"There is significant slowing," said Nariman Behravesh, chief economist at Global Insight, the Waltham forecasting firm. "The worry is that this is the beginning of a trend in which job growth goes negative."
An expanding labor market represents one of the last remaining supports for consumer spending, which drives about 70 percent of all economic activity. Battered by rising energy costs and a slumping housing market, consumers have already pulled back, with US re tailers yesterday reporting December sales rose less than 1 percent from a year ago, according to the International Council of Shopping Centers, a trade group in New York, marking the worst holiday shopping season since the last recession.
As long as the job market expands, even at a slow pace, consumer spending should grow enough to keep the economy out of recession, economists said. But should layoffs accelerate, consumer spending will plunge, taking the economy with it.
"People may become cautious, but they won't cut spending if they have a job," said Mark Zandi, chief economist at Moody's Economy.com, a West Chester, Pa., forecasting firm. "But if they lose jobs, they cut spending, and that leads to a downward spiral" as companies react to the slower demand and cut more jobs.
In his speech before two professional groups, Bernanke cited the weak employment report as the key reason for the gloomier outlook. He noted the Fed has moved forcefully in recent months to offset the effects of the slumping housing market and meltdown in credit markets, injecting billions of dollars into the banking system and cutting its benchmark interest rate three times since September. The benchmark rate now stands at 4.25 percent, following last month's quarter-point decrease.
More interest rate cuts are on the way, Bernanke suggested. When policy-makers meet at the end of this month, economists expect the Fed to slice rates a half-point to 3.75 percent, the lowest since September 2005. Economists project additional cuts in subsequent meetings.
Lower interest rates boost the economy by reducing borrowing costs, thus encouraging consumers and businesses to spend.
"We stand ready to take substantial additional action as needed to support growth and to provide adequate insurance against downside risks," Bernanke said.
Stocks rallied yesterday on the likelihood of rate cuts. The Dow Jones industrial average rose 117.78 to 12,853.09. The broader Standard & Poor's 500 rose 11.20 to 1,420.33. The technology heavy Nasdaq Composite index rose 13.97 to 2,488.52.
The rally was supported by some good news in the job market. The Labor Department reported that the number of people filing first time claims for unemployment fell for the second consecutive week. First time claims, at 322,000 last week, remain well below the recessionary level of 400,000, economists said.
The falling jobless claims could mean that the labor market is not as weak as the December employment suggested, some economists said.
Local staffing firms, which recruit temporary and permanent workers for employers, said yesterday demand for workers in Massachusetts, remains solid. Many economists consider staffing activity a leading indicator of the labor market.
"We are still in a scenario of pretty healthy demand and continued shortage of supply in key sectors" such as nursing, technology, and engineering, said Greg Netland, chief executive of Vedior NA of Wakefield.
Despite last month's weak employment report, Bill Cheney, chief economist at John Hancock Financial Services in Boston, said he expects the economy to "muddle through" and avoid a recession.
"The job market is softening, and not collapsing," he said. "If it goes south, we're really in trouble. But I don't think it has yet."
Robert Gavin can be reached at firstname.lastname@example.org.