- The Washington Times - Wednesday, August 22, 2001

The Federal Reserve yesterday cut interest rates to their lowest levels since 1994, saying rapidly slowing world growth and weak business spending continue to weigh on the economy.
Disappointment and worry about the Fed's downbeat portrayal of the economy sent the stock market diving. The Dow Jones Industrial Average, which had been up 58 points before the Fed announced its quarter-point cut in bank lending rates, plummeted by more than 200 points to end down 146 at 10,174.
The technology-driven Nasdaq Composite Index dropped 50 points to 1,831, bringing its loss so far this year to 26 percent.
With growth hovering around zero in recent months, the Fed said the economy remains at risk from the profits slump and collapse of capital spending that have sharply set back the stock market since last year. The economy has been sustained, it said, by steady household spending and low inflation.
Allen Sinai, president of Decision Economics Inc., said everybody has been disappointed with the economy's weak response to the Fed's massive dose of seven rate cuts, which have totaled 3 percentage points since January. Eventually they will work, he said, but only after a long and sluggish period of recovery.
"It's a matter of time. You pump more medicine into the patient, and eventually the patient gets better," he said. "We've been spoiled" by the economy's strong performance, resilience and rapid rebound from setbacks in recent years.
The torpid pace of recovery is what's hurting the stock market, and the economic stall poses risks in itself since it leaves the economy vulnerable to the perils of a rapidly degenerating world economy for months to come, he said.
"Every day another country indicates much lower economic growth or even outright decline," he said. Japan and the rest of Asia appear to be heading into recessionl; Latin America is in crisis, and European growth is faltering.
"The negative impact on U.S. exports, the U.S. trade and current account deficits, and the U.S. economy appears potentially great," he said. Meanwhile, the "huge downwave in business capital spending" continues to prompt companies to cut production, inventories and staff.
For consumers, worries about mounting job losses appear to be offsetting the stimulative effect of the rate cuts and $40 billion of tax rebates arriving in mailboxes this summer, he said. That is holding consumer spending to lackluster levels that Mr. Sinai expects to prevail for some time to come.
Martin Regalia, chief economist of the U.S. Chamber of Commerce, said Main Street businesses — mostly retailers and service firms — have not been hit as hard as the large corporations that dominate on Wall Street. But they too need to see a pickup in consumer spending to avoid cutbacks in investment spending and hiring.
"Small businesses are not laying off people because it's more difficult for them to find people. They are trying to carry them, and that's causing some profit erosion," he said. The Fed's rate cuts have helped by ensuring a plentiful supply of credit for small businesses, he added.
Major banks quickly passed on the Fed's rate cut yesterday to consumers and small businesses by lowering their prime lending rate from 6.75 percent to 6.5 percent. Many small business loans, credit cards, home equity loans and adjustable-rate mortgages are tied to the prime rate.
"Thus far, the cuts have helped stave off a recession, but they have yet to trigger a rebound," Mr. Regalia said. Still, he expects the recovery to be evident by the end of the year, fueled by consumer spending and renewed spending and production by businesses.
Some economists believe the Fed may be overdoing it in its effort to reassure the financial markets and the public that it will not let the sinking economy fall into recession.
"Additional stimulus, in our opinion, is not necessary as the stagnant economy seems to be on the verge of awakening," said Richard Yamarone of Argus Research Co. "What's more, continued easing would only fuel an already mounting inflation pressure — something the Fed wants to avoid at all costs."
While inflation pressures have gone dormant in recent months, Mr. Yamarone said they remain entrenched in such areas as energy, labor costs and services. Once the economy is into a full recovery next year, he said, those inflation pressures could come back to haunt the Fed.
Also, the recent decline of the dollar, if it accelerates, will raise the price of imported goods and may force the Fed to take back some of the rate cuts next year, he said.

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