- The Washington Times - Wednesday, December 20, 2000

The Federal Reserve, in an abrupt shift, yesterday said the risk of recession now outweighs the threat of higher inflation and signaled it may cut interest rates in coming weeks to shore up economic growth.
A statement released by the central bank's rate-setting committee after a daylong meeting contained a litany of economic woes and made little mention of the inflation risks the Fed cited earlier this year in raising interest rates.
Economic weakness is now a concern, it said, because of "the drag on demand and profits from rising energy costs, as well as eroding consumer confidence, reports of substantial shortfalls in sales and earnings, and stress in some segments of the financial markets."
Given the concerns raised by the Fed, most economists now expect a rate cut at the committee's next meeting Jan. 31. The central bank may move before then if Christmas sales prove to be exceptionally weak, they say.
"There have been a fair number of anecdotes coming in of a big downward shift in consumer spending during December," said Lyle Gramley, a former Fed governor now with the Mortgage Bankers Association. "If this is verified, then the economy needs help."
Fed members no doubt had a lively discussion about whether to cut rates at yesterday's meeting, Mr. Gramley said, but probably decided against it since the holiday shopping season is not over and consumers could still flock to the malls in droves in the days remaining before Christmas or even afterward.
"The Fed's certainly on alert" and ready to act quickly, he said, predicting that Fed Chairman Alan Greenspan will move to cut rates before the next committee meeting if the economy has not clearly snapped back by then.
Among the rapid signs of deterioration that caught Mr. Greenspan's eye, Mr. Gramley said, was a double-digit drop this month in a consumer-sentiment index published by the University of Michigan, eerily like the confidence slumps that preceded recessions in 1980 and 1990.
The Fed also is concerned about this autumn's sharp fall in industrial output, particularly auto sales, he said. "That kind of weakness often ended previously in a recession. You can't rule that out," Mr. Gramley said.
David Jones of Aubrey G. Lanston & Co. said consumers got hit hard this month by astronomical energy bills, particularly electricity consumers in California and the majority of households that are paying record-high prices for natural gas and heating oil to heat their homes this winter.
"It's just shocked people," he said, noting that the energy crunch comes on top of big losses many investors have experienced in the stock market this year, a season of political uncertainty surrounding the presidential election, and significantly higher borrowing costs engineered by the Fed's rate increases between June 1999 and May.
"The slowing in growth is going beyond what the Fed expected," he said. If growth falls below a 2 percent annual rate, the Fed will cut rates three or four times next year to ensure the economy does not fall into recession, he said.
How much the Fed cuts rates depends on whether President-elect George W. Bush can get Congress to approve his tax-rate cuts soon enough to have an effect on the economy next year, he said.
The weakening economy is providing Mr. Bush with a good excuse for the tax cuts that could move through Congress, Mr. Jones said, but enactment of a tax bill remains "tricky" since so many Democrats campaigned against it.
Most likely, the tax cuts will not go into effect until 2002, after the current economic weakness is over, he said.
Wall Street was disappointed that the Fed did not cut rates yesterday. The Nasdaq Composite Index fell 113 points, or 4.3 percent, to 2,512, its lowest level of the year. The Dow Jones Industrial Average closed down 61 points at 10,585 after gaining as much as 139 points before the Fed announcement.
The markets believe the Fed is falling behind the curve by not reacting immediately to signs of anemic growth, said G. David Orr, chief economist with First Union Corp.
But one reason the Fed did not cut rates is to avoid the perception that it is "bailing out" the stock market, which would "ignite another round of speculative activity" in stocks, he said.
Joel Naroff of Naroff Economic Advisers in Holland, Pa., said hopes for a pre-Christmas rate cut were unrealistic.
"There may be a looming recession on Wall Street, but not on Main Street," he said. "Job growth has slowed, not collapsed. Spending has slowed, not collapsed, Income growth has slowed, not collapsed."
The biggest victim of the weakening economy so far has been corporate profit margins, and that is behind the exaggerated reaction in the stock market, he said.
The Fed kept its federal funds overnight bank lending rate at 6.5 percent for now, where it has been since a half-percentage point increase in May. The more symbolic discount rate on Fed loans to banks remains at 6 percent.

LOAD COMMENTS ()

 

Click to Read More

Click to Hide