- The Washington Times - Wednesday, June 25, 2003

The Federal Reserve yesterday trimmed interest rates to their lowest levels in nearly a half-century, saying that despite some recent improvement, the economy is still not growing strongly enough to stave off a lingering threat of deflation and recession.

The Fed’s quarter-point cut in two key lending rates — the main monetary tool, the federal funds rate, fell to 1 percent — is aimed at nurturing a record wave of refinancings and auto and home sales that have been buoying the economy, while enticing businesses to join the consumer party and start hiring and spending again.

The central bank’s statement after a two-day meeting of its rate-setting committee, like its announcement last month, noted a “minor” risk that an “unwelcome substantial fall in inflation” could lead to a debilitating bout with deflation. But it otherwise was upbeat about the prospects for an economic rebound.

“Recent signs point to a firming in spending, markedly improved financial conditions, and labor and product markets that are stabilizing,” the Fed said. “The economy, nonetheless, has yet to exhibit sustainable growth.”

The positive tone was unexpected. Many on Wall Street thought the Fed would cut rates as much as a half-point, citing its fear of deflation. The stock market registered disappointment, with the Dow Jones Industrial Average declining 98 points to 9,012.

Joel Naroff, president of Naroff Economic Advisers, said U.S. consumers and businesses may have seen the last of the Fed’s extraordinary, two-year string of rate cuts.

“The committee is fairly comfortable that the level of monetary and fiscal stimulus already in place, coupled with evolving trends, will generate significant growth in the next few quarters,” he said.

While the Fed left the door open to cutting interest rates further, he said the statement suggests it will not do so if the economy continues to improve.

“Unless there are indications that the economy has faltered further, we may have seen the bottom for mid- to long-term interest rates,” Mr. Naroff said.

Business leaders welcomed the Fed’s move, while noting that it alone will not solve the economy’s problems.

“The Fed is determined to ignite a healthy recovery,” said Jerry Jasinowski, president of the National Association of Manufacturers.

He said it was especially good for small manufacturers, who employ 41 percent of all manufacturing workers and who rely heavily on bank lending to finance economic activity and capital spending.

Mr. Jasinowski said the Fed’s rate-cutting campaign should encourage further declines in the dollar, improving the competitiveness of U.S. exports and helping beleaguered manufacturers regain market share.

The declining dollar is an important tool for fighting deflation, he said, as it causes import prices to rise and enables domestic companies to raise their prices and profit margins. But he noted that the dollar remains 17 percent higher than it was in 1997 and continues to put a strain on American exporters.

Richard Yamarone, economist with Argus Research Corp., said the Fed’s efforts to revive the economy look increasingly desperate and do not appear to be accomplishing much besides strengthening the already robust housing sector.

“Monetary policy is basically impotent,” he said. “There is simply no need for businesses to pick up the pace of investment” and hire more workers as long as demand for their products remains weak and 25 percent of the nation’s plants and factories sit idle.

“Interest rates have been at near-record lows for the better portion of three years, and businesses still haven’t turned to the well,” he said.

The only prominent company that has announced major new borrowing plans is General Motors, he said, and it plans to use the $13 billion it is raising to shore up its pension plan rather than hire new workers or build new plants.

Two reports out yesterday showed the dichotomy in the economy. The Commerce Department reported a second monthly decline of 0.3 percent in orders of big-ticket goods from manufacturers, but it also said sales of new homes surged 12.5 percent to a new record annual level of 1.157 million last month.

“Housing statistics point to another year of record growth,” Mr. Yamarone said, but “one thing is for sure: There’s nothing that a Fed rate cut will do to revive the dead horse of business investment and manufacturing.”

The Fed may be “tilting at windmills,” he said, but it did avoid the mistake of appeasing Wall Street’s demands for a half-point rate cut or appearing panicky like the Bank of Japan when it slashed interest rates virtually to zero in the 1990s.

The Fed’s quarter-point cut was a sensible move, he said. “By acting less aggressively, the Fed is telling the markets that the economy is not dangerously teetering with the economic-compromising effects of deflation like the world’s second-largest economy, Japan.”

The modest decline to 1 percent in the the federal funds rate also helps market psychology by leaving ample room for further rate cuts should the economy falter further, he said.

The Fed also reduced the cost of direct loans to commercial banks, a rate known as the discount rate. The so-called primary credit discount rate fell to 2 percent; a secondary rate for distressed banks fell to 2.5 percent.

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