Minneapolis Fed's Stern sees slow growth, possible US credit crunch

GOLDEN VALLEY, Minn. (Thomson Financial) - Slow growth and rising unemployment -- that now-standard Fed forecast -- was part of the basic outlook Minneapolis Federal Reserve Bank President Gary Stern outlined this morning, but he added the possibility of a credit crunch similar to what happened to the US economy in the early 1990s.

"And while I think the term debt overhang is overly broad, a significant number of homeowners are experiencing considerable strain," he said, and in view of the financial market situation, "the possibility of a credit crunch, and its attendant effects on economic performance, cannot be ruled out."

"Many large banks, both here and abroad," he noted, "have found it desirable to protect balance sheet capacity in the wake of unanticipated asset expansion and material financial losses in some cases as well."

He defined a credit crunch as "as an environment in which quality borrowers find credit either unavailable or available only on very expensive terms", and said "it is possible that an appreciable tightening of credit conditions will" -- as it did in the early 90s -- "restrain the economy for a time."

Those potential headwinds are integral to thinking about economic prospects and policy over the next year or two, Stern said in prepared remarks to the Financial Planning Association of Minnesota.

"To the extent that these headwinds gain momentum, they suggest relatively modest growth for a time and the likelihood of increases in the unemployment rate." Their inflation implications "are not so clear."

In response, the reduction in the target Fed funds rate "appears wholly appropriate," Stern said, in meeting the Fed's responsibility "to restore financial stability and protect the real economy from collateral damage."

Stern was not a voter on the Federal Open Market Committee's string of rate reductions, but will be voting on future policy in 2008 as the rotation of regional Fed bank presidents shifts.

"We take our responsibility for financial stability seriously, and we attempt to ensure that the consequences for the economy of periods of instability are contained," he assured the financial planners.

And Stern held out a bit of optimism.

"We should bear in mind that, after a slow start and with appropriate policy, the 1990s became a decade of growth, of sustained gains in employment, and of diminishing inflation," he said.