Wall St., D.C. Buzz: Will Fed Again Cut Money Rates?
BOSTON — A regular session of the Federal Reserve's policymaking committee June 30 and July 1 has Wall Street and Washington more atwitter than usual.
"There is a feeling that the economic fundamentals could warrant an easing of monetary policy," says Paul Kasriel, an economist with the Northern Trust Company in Chicago.
If the 12-member Federal Open Market Committee decides to lower short-term interest rates again in an effort to accelerate the economic recovery, Wall Street expects this to boost bond and stock prices. Indeed, anticipating this possibility, investors on June 29 pushed up the Dow Jones industrial average 37.45 points to 3,319.86, the sharpest rally in eight weeks.
Washington wonders about the political impact of eased monetary policy. Last week President Bush called for another drop in interest rates. A faster-paced expansion would help the president's reelection prospects.
Fed action might also prompt commercial banks to lower their prime lending rate by 0.5 percent to 6 percent. This would reduce interest charges for millions of homeowners with floating mortgage interest rates or home equity loans. But banks would probably also lower their interest rates on certificates of deposit and various savings or checking accounts.
Because of taxes and inflation, the interest on these accounts is already negative, notes Cynthia Latta, an economist with DRI/McGraw-Hill, an economic consulting firm in Lexington, Mass. These low interest rates trim the income of many retirees.
Recent economic news has been poor. Sales of new homes fell 5.6 percent in May, the fourth straight monthly decline. Orders for machine tools plunged in May, the second straight monthly drop. New orders for durable manufactured goods slipped 2.4 percent in May. Personal income and consumer spending rose only modestly in May. Unemployment in May reached an eight-year high of 7.5 percent. The selling rate of US-made vehicles dropped in mid-June from an already sluggish rate.
Fed officials, according to reports from Washington, are divided on what action to take. So are economists.
"The Fed is engineering a replay of the economy of 1991," warns Lacy Hunt, chief economist for Carroll McEntee & McGinley Inc., New York. After recovery from the 1990-91 recession began in the spring of 1991, economic growth almost came to a halt in the fourth quarter. Hunt calls for the Fed to lower short-term interest rates. This, he says, would also bring down long-term rates and stimulate sales in such interest-sensitive sectors as housing and auto sales.
The economy, he says, is "very frail."
Allan Meltzer, a professor of economics at Carnegie-Mellon University in Pittsburgh disagrees. He suggests the Fed should raise short-term interest rates slightly. This would signal bond buyers that the Fed is serious about its battle against inflation, he says, and result in lower long-term rates.
Such differences stem in part from different readings of money supply trends. Many economists see money as fuel for the economy. One narrow measure of money, M1, which includes currency and checkable deposits, has grown at a 7.2 percent annual rate in the last three months, down from a 16.2 percent rate of growth in the previous six months. A broader measure of money, M2, which includes M1 and some savings and time deposits, has shrunk at a 1.7 percent annual rate in the last three months.
Mr. Hunt says the Fed should boost the growth of M2 at least to within the its target range of 2.5 to 6.5 percent. "The Fed hurts its credibility when it doesn't do what it says it will do," he holds. Hunt describes M2 as "a wonderful indicator" of the future path of the economy.
But Dr. Meltzer says M2 is "misleading." By his analysis, using the various measures of money, money has been growing at a 9 to 10 percent rate over the past year. He argues that a decline in defense spending is one of the major reasons for slow economic growth.