- The Washington Times - Wednesday, December 6, 2000

Federal Reserve Chairman Alan Greenspan for the first time yesterday acknowledged a risk that the steep drop in financial markets this year could trip the economy into recession.
His warning against "excessive softening" in the economy signaled that the central bank's next move may be to lower interest rates and sparked a major rally on Wall Street, where stocks already had begun to rise on hopes that the presidential election impasse may finally be ending.
The beleaguered Nasdaq Composite Index soared a record 10.4 percent or 274 points to 2,890. The Dow Jones Industrial Average jumped 3.2 percent or 339 points to 10,899, its third-largest increase. Before yesterday's rally, investors had lost nearly $3 trillion in stock value since March.
Mr. Greenspan's speech before a group of bankers in New York marked a turning point for the central bank, which since June 1999 has been bent on braking the speeding economy with higher interest rates.
He said the risk of higher inflation now is balanced by a risk of recession posed primarily by the train wreck in the markets and other possible shocks, such as another Middle East oil crisis.
American consumers no longer are being buoyed by gains in the stock market, he said, while U.S. businesses are being hit hard by the cooling economy, a profit crunch caused by high energy prices, and the increased difficulty of obtaining loans or raising funds in the stock market.
Consumers so far have remained strong in this year's more hostile financial environment, but their spending power has been eroded substantially by stubbornly high energy prices, he said.
"With equity prices weakening … the 'wealth effect' that spurred consumers spending is being significantly attenuated," he said. "In an economy that already has lost some momentum, one must remain alert to the possibility that greater caution and weakening asset values in financial markets could signal or precipitate an excessive softening in household and business spending."
Mr. Greenspan noted that the economy is particularly vulnerable because it already is in the process of slowing substantially as a result of the Fed's nearly two percentage points of rate increases between June 1999 and May 2000.
"In periods of transition from unsustainable to more modest rates of growth, an economy is obviously at increased risk of untoward events that would be readily absorbed in a period of boom."
In addition, signs have emerged, he said, that the tight job market is easing, which means that consumers may start to feel threatened by job losses, though it also means that the threat of a wage-led inflation spiral is fading.
Mr. Greenspan said the risk of recession is not as great as it was in the fall of 1998, when a financial tidal wave from the Russian economic crisis threatened to engulf U.S. markets and bring down the economy, and the Fed moved dramatically to cut interest rates.
Still, private economists have increasingly warned of a heightened risk in recent days. Famed forecaster Henry Kaufman told Barron's magazine last week that the odds of recession next year have risen to 40 percent, and a downturn is all but certain in the next three years.
"I know of no time in the last 50 years in which the well-being of the American economy and that of the rest of the world have been so dependent on the strength of the U.S. equity market," said Mr. Kaufman.
"The reversal in the stock market is likely to lead to a significant slowdown, if not a recession, as consumption falls off in its wake," said David Levy of the Jerome Levy Economic Institute in Mount Kisco, N.Y.
The Fed chairman pointed out that one of the biggest dangers is a falloff in business spending on technology investments because of reduced access to the stock market and bank loans. Those investments have been the key to the economy's robust growth, low inflation and rising living standards.
Not all economists are worried about recession, though most say that the risks of a downturn are rising.
"The Fed will ease to avert a recession," said Edward Yardeni, chief investment strategist at Deutsche Bank Securities. "The risk is that the Fed either won't respond fast enough to the weakening economy, or that it may be already too late for the Fed to avert a recession."
Mr. Yardeni noted that consumers "are still in good shape financially," and remain ready to spend. "Americans tend to spend when we are happy and to spend even more when we are depressed."
With the path cleared for possible cuts in interest rates, he said, the travails of the stock market should soon be over. Economists said the Fed could lower interest rates as soon as January.
"The softening stock markets are having an impact," said Joel Naroff of Naroff Economic Advisers in Holland, Pa. "The Fed chairman has let it be known that he is prepared to lower interest rates if he sees any signs that the economy is beginning to spiral downward."

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