- The Washington Times - Tuesday, March 18, 2003

Nobody doubts that Federal Reserve Chairman Alan Greenspan and his colleagues would aggressively react to severe economic dislocations that could result from the imminent war with Iraq. However, in the light of the economy's recent deterioration and under the same rationale the Fed used to reduce short-term interest rates in November, Mr. Greenspan and his colleagues should take out another insurance policy against the current "soft spot" and the potentially devastating economic effects of the coming conflict. At today's Fed policy-making meeting, lowering the overnight interest rate by one-quarter of a percentage point is in order.
When the Fed's policy-making committee convened in December, it acknowledged that the economy was currently experiencing a "soft spot" but declined to reduce short-term interest rates. Having lowered the overnight interest rate by half a percentage point in November to a 40-year low of 1.25 percent, the Fed argued that its "accommodative stance of monetary policy, coupled with still robust underlying growth in productivity, is providing important ongoing support to economic activity." At its meeting in late January, the committee again decided against reducing short-term rates. The Fed noted that oil price premiums and "other aspects of geopolitical risks" had been "foster[ing] continued restraint on spending and hiring by businesses." But the Fed concluded that, "as those risks lift," the continuing impact of previous monetary expansion and the favorable productivity trend would "provide support to an improving economic climate over time." The Fed convenes today amid economic news that has not been good, as evidenced by the central bank's own Beige Book, which reported that "growth in economic activity remained subdued in January and February." Compared to more recent data, that analysis seems subdued.
Since the March 5 release of the Beige Book, which was based on economic information collected through Feb. 23, subsequent reports have confirmed how poorly the economy has been performing.
Meanwhile, oil price premiums, acting as a large tax on the economy, have soared since January; the price of oil recently approached $40 per barrel on the New York Mercantile Exchange. Retail sales for February fell 1.6 percent, a plunge that reflected broad-based declines in consumer durables (autos, furniture, electronics, appliances, etc.) and in large nondurable sectors (entertainment, groceries and clothing). The University of Michigan's preliminary March estimate of consumer sentiment declined to the lowest level since October 1992; the index has fallen 17 percent over the past three months and 28 percent over 12 months. Meanwhile, industrial production limped forward in February, rising by a mere 0.1 percent, as unused industrial capacity remained near 25 percent.
Not surprisingly, economic forecasters have sharply ratcheted down their estimates of economic growth for this quarter, the next quarter and the year. The dismal economic performance has blown a hole in the federal budget, exacerbating the deficit as tax revenues continue to fall well short of projections.
To be sure, geopolitical risks related to the imminent war with Iraq and their financial consequences have contributed to the dismal economic performance of late. But the recent deterioration seems to have accelerated above and beyond the geopolitical factor. An interest-rate reduction now is clearly in order. If subsequent events, both economic and geopolitical, demonstrate the rate cut to have been unnecessary, it can be easily and quickly reversed.

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