Fed feared deflation in ’02

Just-released transcripts show the Federal Reserve was worried about the threat of deflation when it decided to cut a key interest rate by a half-point in November 2002. Then-Fed Chairman Alan Greenspan called the prospect “pretty scary.”

Those transcripts, released Friday, showed that Greenspan and his colleagues were focused on what should be done about a sluggish economy and the threat that the country could tumble into a period of deflation, something the nation had not experienced since the Great Depression.

Although the Fed seeks to achieve low inflation, it does not want to see the economy enter a period of serious deflation with the value of real estate and other assets dropping, because that sets off destabilizing forces that can have serious consequences.

Some critics have said that there was never a serious threat of deflation in the U.S. in the 2001 recession and that the extremely low interest rates engineered by the Fed created a housing boom that drove prices and sales to record levels only to burst in 2006, sending shock waves through the economy that still reverberate.

The transcripts released Friday show that Fed officials at the time were not too worried about the effects low interest rates might have. They argued that if inflation started rising the Fed could reverse course and start raising rates, but that deflation would be harder to combat.

The Fed did cut the federal funds rate -- the interest that banks charge on overnight loans -- by a half-point at the November 2002 meeting, moving it from 1.75% to 1.25%, the lowest level in 41 years.

Greenspan expressed concern about the country falling into a “deflationary hole.”

“It’s a pretty scary prospect, and one that we certainly want to avoid,” Greenspan told other members of the Federal Open Market Committee.