The hyperactive Federal Reserve did it again Tuesday, cutting interest rates by one-half of a percentage point for the fifth time this year in its extraordinary, if not historic, war against recessionary forces in the economy.
In reducing its benchmark interest rate on overnight bank loans to 4 percent, the central bank under Chairman Alan Greenspan delivered just what financial markets expected as it once again demonstrated its determination to ward off an economywide decline.
Although some analysts thought the Fed might take a rest from its relentless interest-cutting offensive, others said they expected the central bank would trim rates again in late June and maybe more later this year if the economy shows signs of taking a dip or remains too close to recessionary levels.
While noting that the reduction of a glut in inventories was “well advanced” and consumer spending has held up, the Fed signaled its concern about declining business investment in new capital equipment, a key to economic growth and job creation. It said an erosion in current and future profits threatened to keep such crucially important investment depressed.
“This potential restraint, together with the possible effects of earlier reductions of equity wealth on consumption and the risk of slower growth abroad, continues to weigh on the economy,” the Fed statement said. In citing declines in equity wealth, the Fed referred to dramatically lower stock portfolios that have caused many Americans to scale back spending.
Wall Street showed little reaction to the Fed announcement. The Dow Jones industrial average closed the day at 10,872.97, down 4.36. The technology-heavy Nasdaq gained 3.66 to close at 2085.58.
The Fed’s rate cut will be felt immediately by Americans who have any kind of debt in which the interest rate is adjustable–most typically, home equity loans–or is short term in nature–such as automobile loans. Adjustable-rate mortgages will be less costly, but some analysts said they did not expect interest rates on 30-year fixed mortgages to show much change.
David Wyss, chief economist for Standard & Poor’s, called the rate reduction “an insurance policy by the Fed in case things don’t turn out.” He said there is still a risk that the economy could sink into a recession, even though it grew by a modest 2 percent in the first quarter.
Stan Shipley, economist for Merrill Lynch, said he expected another interest rate reduction in June and perhaps another in August. What is clear, he said, is that Greenspan will use all the monetary policy power he has to keep the economy afloat until lower tax rates kick in this year.
“We have had some of the most aggressive Fed cuts you’ve seen in our history,” he said.
Brian Wesbury, chief economist for Chicago’s Griffin, Kubik, Stephens & Thompson Inc., said the five-month rate-cutting spree compares favorably with interest rate declines under Fed chief Paul Volcker in the early 1980s, when the economy was in a more serious recession and rates topped 20 percent.
“Never have I seen anything like this,” said Wesbury. He theorized that Greenspan might be cutting interest rates so quickly and deeply because of his experience in the 1990-91 downturn, when it took the economy at least two years to recover fully with a series of small, incremental interest rate reductions.
Confidence crisis
Judging from his actions, Greenspan has undergone what some analysts say is a remarkable conversion from a highly cautious Fed chief to a monetary general using the Fed’s full arsenal of anti-recession weaponry against a slowdown.
With his two latest rate cuts in particular, he appears to have silenced critics who believed he was moving too slowly against the threat of a recession and against a sharp decline in stock market prices that made many Americans feel less confident.
Greenspan’s offensive against a recession has a strong psychological content. When the slowdown developed quickly late last year, he made it clear his biggest worry was a sharp breach in consumer confidence, which he said could send the economy into a deep dive.
He appears to have succeeded in arresting that concern, although consumer confidence remains extremely fragile. But the economy has yet to show any dramatic recovery despite the interest rate cuts he and his Fed colleagues have made.
Many analysts blame Greenspan for the economic slowdown, saying he raised interest rates too much over an 18-month period ending last May. Those increases brought the boom to an end, spurred a series of high-profile layoffs and caused a big buildup in inventories as consumers scaled back spending.
Greenspan has taken back all those rate increases and then some. Now the overnight bank lending rate the Fed uses to influence all other short-term interest rates is at 4 percent, roughly equal to the annual growth of the economy without adjustment for inflation. The central bank also reduced its discount rate, the interest rate it charges member banks for direct borrowing from the Fed, to 3.5 percent from 4 percent.
Fed’s job done
Paddy Jelik, economist for Credit Suisse First Boston Corp., disagreed that the Fed would continue its hectic interest rate-cutting pace. Jelik said Greenspan has given the markets what they wanted and has “basically done its job” of stopping consumer confidence from falling. “Now the Fed should take a breather,” he said. “The Fed can afford to sit and pause and be more reactive than proactive.”
According to Jelik, the statement Tuesday by the central bank’s Federal Open Market Committee, its policymaking arm, lacked the urgency of previous statements about the economy. Other analysts took issue with Jelik, saying that Greenspan appears to be on a crusade rarely seen in a usually supercautious Fed chief.
“They’re trying to push the economy,” Wyss said. “The Fed doesn’t mind slow growth, but they are worried about it turning into a real recession. Alan Greenspan doesn’t want a recession on his watch.”
Wyss said he expected only a one-quarter of a percentage point interest rate reduction to result from a two-day Fed meeting beginning June 29.
The Fed statement confirmed “business confidence is causing us more problems than consumer confidence,” Wyss said. “It’s those pessimistic CEOs cutting back on investment who are causing trouble.”
Even with 2 percent growth in the first quarter, said analysts, the economy remains in trouble. Wesbury said the first-quarter rise was primarily due to smaller-than-expected imports, and this figure would be revised downward. Manufacturing is still in a recession, he said, and “weakness there is spilling over into the service sector.”
“The only thing keeping the economy afloat is the willingness of American consumers to live beyond their means,” Wyss said. “There’s always the risk that we might start saving money one day.”
It takes time for interest rate reductions to have an effect. Some see a lag of six months to a year before the full impact is realized.
“I would expect that by the fourth quarter, you would start to see some better growth,” Shipley said.
