- The Washington Times - Thursday, November 7, 2002

The Federal Reserve yesterday slashed interest rates by a half-point to the lowest levels since John F. Kennedy was president to pull the economy out of what it called a "soft spot."
The Fed's surprisingly aggressive move, its first rate cut since December, came amid signs that consumer spending, production and employment had stalled after making fitful starts toward recovery earlier this year. The action was aimed in part at bolstering flagging confidence.
The Fed's midafternoon announcement, along with news of a Republican takeover of the Senate in the midterm elections, spurred a modest rally in the stock market, with the Dow Jones Industrial Average advancing 93 points.
While the Fed's action should enable automakers to continue offering zero-percent-interest loans to buyers, economists said, its main effect may be psychological because rates already were at the lowest levels in a generation and were stimulating record sales of houses and automobiles.
"This latest move was largely a gesture to the American investing public, as the Fed doesn't want to appear uncaring or oblivious to the current economic and financial difficulties," said Richard Yamarone of Argus Research Co.
The unprecedented levels of auto and housing sales demonstrate that the Fed's 11 rate cuts during the recession last year have accomplished their mission of spurring the most interest-sensitive sectors, he said.
The economy's current ailment primarily a lack of spark and momentum is less responsive to a dose of rate cuts, Mr. Yamarone said.
"The problem the U.S. economy currently faces is that businesses aren't generating profits sufficient enough to increase investment or hire new workers.
"And in the attempt to recoup some degree of profitability, businesses have been forced to lay off workers, which are the greatest costs to business," he said. "This employment softness has transmitted throughout the household sector, denting confidence and curtailing consumer spending."
Sung Won Sohn, chief economist with Wells Fargo & Co., said, "The central bank has taken out an insurance policy to support the economy," partly in anticipation of a U.S. war with Iraq this winter. The Fed's statement said worries about "heightened geopolitical risks" were partly to blame for the economic lull.
But Mr. Sohn said the rate cut is likely to have little real effect on an economy already awash with cheap credit and may be counterproductive if it confirms fears of a trend toward recession.
"The move could backfire by announcing to the world that the economy was so weak that Chairman [Alan] Greenspan had to use what little ammunition he had left to shore up the economy," he said.
Yesterday's cut brought the federal funds rate, the main tool by which the Fed influences the economy, to 1.25 percent. The discount rate the Fed charges on emergency loans to banks was slashed to 0.75 percent. Banks were expected to lower the prime rate today.
The dollar declined after the Fed's announcement, indicating renewed concern about weakness in the U.S. economy. Tepid reaction on the stock market appeared to reflect ambivalence about whether the action signaled economic recovery or trouble ahead, analysts said.
The U.S. Chamber of Commerce and National Association of Manufacturers said the rate cut should help businesses and consumers slow the rate of bankruptcies, which have reached record levels.
"Well done," said Joel Naroff of Naroff Economic Advisers, noting that the Fed took pains to say that it believed the economy had hit a soft spot like the one in the spring and would recover in the months ahead.
The Fed said this rate cut should set the economy back on the road to recovery and indicated that it was not leaning toward further reductions.
"In essence, the economy will have to tank in the next few months to get another move," Mr. Naroff said. "The Fed also made it clear that the current situation is being made worse by Iraq and when that is resolved, they think the economy is poised to move ahead solidly."
The economy also is likely to receive help from the new Republican-led Congress, analysts said. The Republican takeover of the Senate should end the gridlock that has prevented passage of growth-inducing measures, such as terrorism insurance legislation and an energy-development bill.
Also likely to be high on Republicans' agenda next year will be proposals to extend and accelerate President Bush's $1.35 trillion of tax cuts, as well as targeted new tax cuts to help investors and retirees recover from devastating losses in the stock market.
Additional tax cuts and defense spending under the Republicans should boost the economy, but they also pose the danger of perpetuating the triple-digit budget deficits that re-emerged during the recession, economists said. That eventually would lead to elevated interest rates, they said.
"This is an historic moment and an exciting opportunity for those of us who advocate pro-growth policies," said Jerry Jasinowski, president of the manufacturing association. "We can jump-start a variety of legislative initiatives that have gotten bogged down and get our economy growing again."

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