Budget, Interest Rate News Buoy US Economic Spirits

IT isn't Christmas yet - but Washington is already making cautious moves intended to help the American economy have a happy New Year.

Taken aback by instability in the stock market, Congress and the White House have toned down their rhetoric and vowed to work toward a balanced-budget deal by January. At the same time, the Federal Reserve has pushed a key interest rate down a notch in an effort to throw a log on the sputtering fire of US business activity.

Some economists expect further Fed reductions early in 1996, especially if car sales and other big-item retail activity remain lackluster. Short-term rates should decline another 3/4 of a percent "by the time the snow melts," says Don Straszheim, chief economist at Merrill Lynch.

A credible federal budget agreement would only intensify any Fed effort at economic stimulus. If the budget-Fed interaction goes well, long-term mortgage rates might fall to as low as 6.5 percent in the spring.

At that historically low level, more "people will begin to think about buying homes, mortgages, and refinancing. It will be pretty healthy for the economy," says David Lereah, chief economist for the Mortgage Bankers Association in Washington.

As of this writing, the prospects for an end to the fall's long budget showdown between the White House and GOP revolutionaries in Congress remained uncertain. But if nothing else, an end to sound-bite sniping was possibly at hand.

It's a Washington truism that chances for political agreement are inversely proportional to the number of people sitting in a room and their seniority. Thus Wednesday's scheduled meeting between President Clinton, House Speaker Newt Gingrich (R) of Georgia, and Senate majority leader Bob Dole (R) of Kansas, was a good sign. Previous budget negotiations have tended to involve more people - as many as 16 at one point. Wrangling has been led by senior staff, not the top dogs themselves.

Hammering out details hasn't been the main obstacle to reaching a seven-year balanced budget plan both sides can sign, after all. Instead, lack of political will may have been the major impediment. The hands of GOP negotiators have been tied by zealous House Republicans who believe strongly in their balanced-budget goals; President Clinton, for his part, has seen his poll numbers rise as he positions himself as the defender of Medicare and Medicaid.

Clinton's rope-a-dope defensive strategy may be nearing the end of its usefulness, however. Americans generally support adequate funding for entitlements, but the overall goal of a balanced budget is also widely popular, and if budget talks irretrievably break down the White House may suddenly find itself taking a major share of the blame.

"The voters may say 'you are the captain of the ship. It's not enough to complain that the guys down in the engine room screwed up,' " says Robert Reischauer, a Brookings Institution expert and former head of the Congressional Budget Office.

Monday's 100-point drop in the Dow Jones Index may provide both sides the political cover they need to move off their long-held positions and restart the government after deadlock produced this week's Shutdown II.

Stocks generally recovered on Tuesday, and analysts agreed that budget uncertainty was only one reason for the Dow's sudden plunge, but neither party may want to be seen as damaging the economy via intransigence at the beginning of a presidential election year.

The Federal Reserve, for its part, appeared intent on taking no economic chances. Many observers had felt that with no budget deal in place, Fed officials might stand pat at their Dec. 19 meeting. Instead, they delivered an early interest-rate Christmas present, voting to reduce the key federal-funds rate from 5.75 to 5.50 percent.

Exactly why the Fed acts is never entirely clear. Fed officials often try to obfuscate their actions. But mediocre retail sales likely played a part in their thinking. "The Fed is taking on a little more insurance against an [economic] accident," says Paul Kasriel, chief economist for the Northern Trust Company in Chicago.

Current low levels of inflation allowed the Fed room to reduce interest rates without worrying about overheating the economy and igniting a damaging rise in prices. The Consumer Price Index has now declined to 2.6 percent annual inflation, measured year after year. That contrasts with a 3.2 percent CPI the last time the Fed cut rates, in July.

The latest cut by the Fed is not really enough to send such key consumer interest rates as mortgages into a precipitous decline. Prior to the Fed move, a borrower could generally obtain a 30-year fixed rate mortgage for 7.25 percent. After the Fed announced its rate cut, this 30-year rate came down to 7.15 percent.

A federal budget deal might send mortgages and other consumer-loan rates down further. Perhaps more important, the absence of a budget deal might send them back up.

"If there is no progress, rates could creep up a bit," warns David Lereah of the Mortgage Bankers Association.

*Staff writer Ron Scherer contributed to this story from New York.