- The Washington Times - Wednesday, January 30, 2002

In 11 incremental steps last year, Federal Reserve Chairman Alan Greenspan and his colleagues cumulatively slashed the federal-funds interest rate by 4.75 percentage points, reducing the key overnight rate from 6.5 percent to 1.75 percent, its lowest level in more than 40 years. This week, the Fed's monetary-policy committee meets for the first time this year. What should Mr. Greenspan and policymaking colleagues do? For several reasons, now may be the right time for a breather.

In the first place, history has demonstrated that monetary policy affects the economy after long and variable lags. In the past, those lags have lasted as long as 22 months once the business cycle trough was reached, according to a seminal study by economist Milton Friedman. Since June, there have been six reductions in the target overnight rate, which has fallen by more than 2 percentage points since then. In other words, there is still a lot of stimulus coming through the monetary pipeline.

Secondly, fiscal policy has helpfully moved from its decidedly contractionary phase, when projected surpluses for the current fiscal year exceeded $300 billion and threatened to counteract the much-needed stimulative effect of monetary policy. Largely in response to September 11, federal spending has already expanded well beyond the levels contemplated earlier last year.

Thirdly, the current recession is now in its 11th month, which has been the length of the average postwar economic downturn. The fiscal-policy reversal has been such that Mr. Greenspan last week told the Senate Budget Committee that an economic stimulus bill may no longer be "a critically important issue to do." The Fed chairman told the committee he thought "the economy will recover in any event."

The final reason the Fed should hold its fire this week is that it needs to preserve as many monetary arrows in its quiver as possible. Nominal interest rates cannot fall below zero, and the Fed is already closer to that level than it has been in four decades. In the event that the economy's self-correcting process needs a decisive boost from the Fed down the road, the ammunition must be available. Witness the dilemma facing Japan's central bank, whose overnight call rate has been 0.001 percent for some time. Even as Japan's economy continues to fall deeper into recession, its central bank is powerless to act, having already exhausted its firepower. That is a policy dilemma the Fed must avoid at all cost.

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