Fed's Rosengren sees more risks ahead

Low interest rates aren't quite working, Boston chief warns

A credit crunch that began on Wall Street a year ago has spread throughout the banking system and muted the impact of Federal Reserve interest rate cuts aimed a boosting the struggling economy, said Eric Rosengren, president of the Federal Reserve Bank of Boston.

Rosengren, speaking in Manchester, N.H., yesterday, said the slumping economy, mounting financial losses, and fears of rising loan defaults have made banks reluctant to lend to businesses and consumers even though the Fed's benchmark interest rate remains at a historically low 2 percent. This contraction of credit, in turn, could further weaken the economy in the second half of this year and help push the national unemployment rate above 6 percent, Rosengren said.

The unemployment rate was 5.7 percent in July.

Though he doesn't have a vote on the Federal Open Market Committee, Rosengren's remarks signal that he favors holding the benchmark federal funds rate at its current low level. That's in contrast to a minority of other Fed officials who argue the central bank needs to start raising rates soon to snuff out inflation, which is running at its fastest pace since the early 1990s.

The Fed committee holds an interest meeting Sept. 16, and most economists expect it to hold rates steady.

The nation's central bank typically cuts interest rates to boost the economy by encouraging businesses to borrow and spend - and raises rates to slow spending and demand before prices begin to rise rapidly. But lower rates aren't providing much stimulus to the economy today because lenders don't want to lend, Rosengren said.

A recent Fed survey of lending officers found that nearly 60 percent of banks have made it harder for large businesses to get loans and 65 percent have made it harder for small firms. That's a higher percentage than during the credit crunch of the early 1990s, Rosengren said.

In addition, the survey also found that banks are not following the Fed's lead in lowering rates. In fact, at least 70 percent said they had increased interest charges for business loans. Mortgage rates have barely changed even though the Fed has cut its rate by more than 3 percentage points over the past year.

"Many business borrowers and consumers are finding their access to credit has diminished, and their cost of credit has risen," Rosengren said. "The reductions in the federal funds rate have done little but offset the tightening occurring in the marketplace in response to credit crunch conditions."

Rosengren, who studied the New England credit crunch of the 1990s as a Boston Fed researcher, has argued on other occasions that the tighter credit conditions require low Fed rates. He said yesterday conditions would be far worse if the Fed hadn't aggressively cut interest rates and pumped billions of dollars into the financial system.

The economy remains weak, according to a Fed survey of economic conditions, known as the Beige Book. The survey, released yesterday, found consumer spending slowing, manufacturing and residential real estate still weak, and commercial real estate deteriorating in most parts of the country.

In New England, economic conditions were mixed. Retailers, software, and information technology firms reported increasing sales, while manufacturers said their sales were down. Real estate markets continue to struggle, and home prices continue to fall.

Robert Gavin can be reached at rgavin@globe.com.