- The Washington Times - Wednesday, May 16, 2001

The Federal Reserve said yesterday that the danger of recession has not passed, prompting it to cut interest rates to their lowest levels in seven years.
The central bank surprised Wall Street and many Fed watchers by dismissing the threat of inflation from rising energy, health care and labor costs. It cited the threat to the economy from the financial clouds hanging over consumers and the collapse of business investment and profits.
The Feds gloomier-than-expected assessment led it to slash short-term interest rates by a half percentage point for the fifth time this year, twice the amount some analysts were expecting. And the Fed signaled it is prepared to order more rate cuts if economic weakness persists in coming weeks.
"They were about as clear as you can get in putting down the inflation bugaboo" raised recently by investors and economists, said Martin Regalia, chief economist with the U.S. Chamber of Commerce. He said he was surprised by the Feds statement that "inflation is expected to remain contained."
A consumer inflation report due out this morning is expected to show significant damage from gasoline prices that surged last month to record highs around $1.70 a gallon, spiraling power prices in the West, and medical and labor costs running at rates over 4 percent.
The Fed noted signs that consumer spending so far has "held up reasonably well" and a cycle of inventory drawdowns that has depressed the economy since last year seems to be largely over. The Feds statement was issued after a daylong meeting of its rate-setting committee.
Those signs of improvement have led some Fed watchers to say that the Feds mission of saving the economy from recession is nearly complete and the economy should see a significant pickup in growth in the second half of this year.
David Orr, chief economist with First Union National Bank, said a recent jump in long-term interest rates suggests that investors think the Feds extraordinary rate-cutting campaign this year, the most aggressive in 16 years, could overstimulate the economy and cause an inflation problem.
"Given the better-than-expected news late last week on retail sales and consumer spending, many analysts had thought the Fed would signal that it saw a light at the end of the tunnel, so to speak, hinting at less aggressiveness going forward," he said.
But the Fed said factors such as slowing growth overseas and the loss of household wealth from the last years drubbing in the stock market "continue to weigh on the economy" and pose an overriding risk of recession.
Mr. Regalia said the central bank is more worried about consumers than it lets on, partly because of high levels of household debt, which combined with losses in the stock market have put the financial health of many consumers in jeopardy.
The Feds dramatic cuts in the rates it charges banks, which banks immediately passed along to consumers by lowering their prime rate from 7.5 percent to 7 percent yesterday, should make those debt loads more bearable.
Consumer spending is still growing, but it has dramatically slowed in the last year and probably has fallen to an anemic rate of about 1.5 percent in the current quarter — less than half the first quarters 3.25 percent rate, Mr. Regalia said.
"If consumption starts to wane, were going to be in a very bad situation" since consumer spending accounts for two-thirds of economic activity, he said. "Clearly, the Fed is trying to maintain consumer confidence," which has been shaken by the falling stock market, rising energy prices and rising joblessness.
The stock market shrugged off the Feds rate cuts, with the Dow Jones Industrial Average falling 4.36 points to 10,873 and the Nasdaq Composite Index rising 3.66 points to 2,086.
The jump in unemployment to 4.5 percent since October is worrisome to consumers, Mr. Regalia said. But he was optimistic that, while unemployment may rise to 5 percent by the end of the year, businesses will avoid bringing on a recession with big layoffs.
The small businesses that belong to the chamber employ most of Americas workers, and while they have slowed hiring, they are not yet laying off workers, he said. That is because small businesses for years endured a tight labor market and shortage of workers.
"Theyre scared to death to lay anybody off because they might not get him or her back again," he said. "Theyre going to hold on to the labor force as long as they possibly can. Theyll let profit margins erode a little bit" rather than fire workers, he said.
Jerry Jasinowski, president of the National Association of Manufacturers, said the Fed may have been moved by its own report on Monday showing a seventh straight month of contraction in manufacturing that leaves American industry in its worst shape since the last recession.
"In cutting rates rapidly, the Fed was well aware of the danger of a vicious cycle of falling profits and company cutbacks in employment and capital spending," he said.
Some economists noted subtle signs in the Feds statement that it may soon stop cutting rates. Most notable was a lack of urgency in the wording, unlike a statement that accompanied a surprise rate cut by the Fed on April 18.
The Feds "rhetoric" suggests it is ready to cut rates again, but most likely none will be needed, said Neal Soss, economist with Credit Suisse First Boston.
The rebound in the stock market since the Feds April rate cut and the revival of appetite among investors for newly issued corporate equity and debt suggests that an economic recovery is on the way and the Feds work is done, he said.
Another major factor that should promote growth later this year is the $60 billion to $70 billion tax cut that President Bush and Congress are planning to pass out after Oct. 1, he said. While high energy prices will depress growth this summer, he said, the tax cut should spur growth to a robust 3.4 percent annual rate in the fourth quarter.
"Its nearing time to pass the baton of economic stimulus from the Fed," Mr. Soss said.
L. Douglas Lee, president of Economics from Washington Inc., said the tax rebate should boost consumer spending by 10 percent this year and, with generous increases in spending being contemplated by Congress, provide a sizable stimulus to the economy that the Fed must take into account in the future.
He said gradually rising inflation concerns also will eventually rein in the Fed.
"The longer inflation runs above expectations, the harder it becomes to dismiss," he said.

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