Citing an erosion in consumer and business confidence threatening to stall out the economy, the Federal Reserve stepped up its anti-recession offensive Wednesday by lowering interest rates by half a percentage point for the second time in a month.
The central bank’s move will bring down borrowing costs on goods and services in virtually every corner of the economy. But analysts said the Fed’s action will, at best, be slow-acting against a rapidly developing economic slowdown that some say can now be termed a recession.
The Federal Reserve’s policymaking arm, the Federal Open Market Committee, served notice it was poised to make further cuts if necessary to calm what appears to be a strengthening economic storm, complete with rising layoffs, falling confidence, and weakening sales and production.
The Fed, chaired by Alan Greenspan, said it acted because “consumer and business confidence has eroded further, exacerbated by rising energy costs that continue to drain consumer purchasing power and press on business profit margins.”
Some analysts said they expected the Fed might cut interest rates again before the next scheduled meeting of the Federal Open Market Committee on March 20. As a result, interest rates could fall another percentage point within the next few weeks as the Fed seeks to head off a downward spiral in the economy, they said.
If a recession should indeed develop, most economists said, it will likely take place in the first half of this year and be over in the second half, although even then economic growth is not expected to be strong. The odds of a longer downturn are seen as small, although some analysts do not rule it out.
Financial markets had widely expected the Fed’s move, so its effect on stock prices was muted. The Dow Jones industrial average closed barely in positive territory, while the Nasdaq composite index dropped 65.62 points. But the central bank clearly was trying to turn around gloomy consumer and business psychology by lowering the cost of the most basic commodity in the economy–money.
That gloominess had been underscored by the Conference Board, a business group, which reported Tuesday that consumer confidence had dropped to a four-year low. Last week, Greenspan told Congress he was concerned that consumer confidence could be damaged by the decline in sales and production.
The Fed’s latest rate cut came on a day the government reported that the economy in the fourth quarter of 2000 grew at an annual rate of only 1.4 percent, its slowest rate in more than five years and far below the rates Americans enjoyed during much of the 1990s boom.
The one bright spot came in a report showing that December new home sales took the biggest jump–13.4 percent–in more than seven years, a surprise to most analysts who had been expecting the home sales market to soften.
The Fed shifted from fighting inflation to fighting recession on Jan. 3, when it announced a surprise half-point cut in short-term interest rates–the so-called federal funds rate that commercial banks charge each other for overnight borrowing. This rate is key in determining the level of all other interest rates.
On Wednesday, the Fed reduced the federal funds rate to 5.5 percent from 6 percent. On top of that, it approved a further half-point cut in its discount rate, which it charges banks for direct borrowing. With these moves, a number of commercial banks lowered their prime lending rate, charged to their biggest and best customers, to 8.5 percent from 9 percent.
The prime rate is one benchmark built into many types of borrowing costs, such as adjustable rate mortgages and home equity loans. Dropping it will put more spending money into people’s pockets–precisely what the Fed had in mind to combat a possible recession.
“The economy’s in a recession and the Fed is responding accordingly,” said Steve Roach, chief economist at Morgan Stanley Dean Witter. “They have moved very aggressively in a 28-day period. But they’ve got a lot more to do. At the minimum, I think there will be another [1 percentage-point cut] on top of this.”
While others said the economy may avoid a recession, they added that it would just barely do so. “There are signs from indicators in the financial markets that would suggest there is light at the end of the tunnel,” said Paul Kasriel, senior economist at Northern Trust Corp. in Chicago. “We really won’t see much of that light for a while.”
A recession is often defined as two consecutive quarters of decline in gross domestic product, the market value of the output of the nation’s goods and services. The last recession, in 1990-91, lasted for only six months, but it contributed to the defeat of President George Bush in 1992.
The recent slowdown has improved the chances for a major tax cut, even though Congress isn’t expected to approve it for months. President George W. Bush is pushing a $1.6 trillion tax cut over 10 years, but Democrats want a plan only half that size.
The Bush plan got another boost Wednesday when the Congressional Budget Office raised its surplus estimate for the next decade by an additional $1 trillion, to a total of $5.6 trillion, a figure that includes the surplus in Social Security. At the same time, a prolonged recession could call into question these optimistic estimates, said Northern Trust’s Kasriel.
Economists cite many causes for the slowdown, ranging from a stock-market bubble fueled by high-tech overvaluations to a surge in energy prices. But many blame Greenspan’s Federal Reserve for raising interest rates six times in less than two years, with the last increase occurring in May 2000.
“The one cause is the Federal Reserve,” said Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson Inc. in Chicago. “I think they raised interest rates too far, and they held onto them for too long.”
But others said Greenspan was merely trying to puncture a bubble in stock prices that, if left unchecked, might have grown larger and at some point collapsed much in the same way that it did in 1929, taking the economy into a deeper and more prolonged recession.
Roach put his finger on the sharp run-up in “new economy” technology stocks as the main cause of the slowdown. “We bought this new-economy mania of the Nasdaq as if it were the be-all and end-all of American prosperity,” he said. “We went too far.”
Another possible reason cited by analysts is that the record economic expansion may have more naturally run out of steam as American consumers, after accumulating so much in a consumption binge that raised their debt levels, scaled back on purchases. That decline in consumer spending caught companies by surprise and with huge inventories on hand.
John Veitch, head of the economics department at the University of San Francisco, said what happens to the unemployment rate in the next few months will be critical in determining whether the U.S. has a mild downturn or a sharp one. The jobless rate was 4 percent in December, but many analysts said the January figures–to be released Friday–might show an increase.
Recent layoffs at many companies suggest that Corporate America isn’t as patient about keeping workers as in past slowdowns, Veitch said. If the jobless rate surges, he said, it will be another major blow to consumer spending.
Veitch said the slowdown in the Bay Area is evident. “First it was the Internet companies, and now you are seeing it take place with consultants and the advertising people who sucked money out of the start-ups. We are going to see the same thing happening with law firms.”
The Fed’s move is an effort to turn around this negative psychology, Veitch said. Major U.S. banks move to cut prime lending rate.
