Amid Global Crisis, Fed Tries Leading by Example
Other nations join ranks with US central bank in cutting their own interest rates.
BOSTON — After almost 20 years of fighting inflation, sometimes at great economic cost to the nation, the Federal Reserve has quietly shifted goals. Its biggest foe now is world financial crisis.
In efforts to help the US economy glide through the global downturn - and perhaps lessen the impact of financial turmoil on other nations - America's central bank is using a familiar tool for managing the economy - interest rates.
But it is also engaging in a less familiar role: setting an example for other nations.
"The Fed is exercising leadership in a turbulent world," says Stephen Roach, chief economist for Morgan Stanley, an investment banking firm in New York.
A number of other nations may join with the Fed by adopting similar strategies.
Already, shortly after the Fed moved Tuesday to trim short-term interest rates by 0.25 percentage point, the Bank of Canada lowered a key interest rate the same amount.
In Ottawa, Canadian Finance Minister Paul Martin urged "appropriate monetary policy" by the Group of Seven most-industrialized nations to allay "the risk of a further slowdown in the global economy." It was seen as a call for interest-rate cuts by other nations. Analysts say other central banks may follow soon, such as those of Britain and Italy. Japan, hit by recession, trimmed its rates close to zero two weeks ago.
Germany's new government has expressed sympathy for the idea of lower rates. "The question is why in Europe, with such [high] unemployment, the central banks have not been able to agree on such a step," Finance Minister Oskar Lafontaine said this week.
But Germany's independent central bank, the Bundesbank, has indicated it has no plans for a cut. Continental European central banks have been seeking to unify interest rates before the common euro currency is introduced early next year.
Also joining the call for more action to prevent global recession were the finance ministers of the Commonwealth, meeting in Ottawa. "Containment ... requires concerted and prompt action by the Group of Seven," Emeka Anyaoku, Commonwealth secretary general chief, told delegates at an opening ceremony of the 54-member nations' meeting.
Impact of rate cut
To an economist, the Fed's small change in interest rates will have little impact on US economic activity, and then only after 12 to 18 months. Some commercial banks, though, have already lowered their prime rate to 8.25 percent, down 0.25 percentage point - a move that should lower costs slightly for those with home equity loans or auto loans.
Still, the Fed's move is seen as primarily psychological, an effort to bring resolve where there is despair and hope where there is gloom.
"It says, 'You have a friend in [Fed Chairman] Alan Green-span,' " notes Paul Kasriel, an economist at Northern Trust Co. in Chicago.
The rate cut was not unexpected. In fact, many investors had hoped the Fed might trim interest rates by 0.5 percentage point, twice as much as it did. Stock market prices declined modestly Tuesday in mild disappointment. Abroad, in markets such as Tokyo and Hong Kong, stock prices were flat yesterday.
"There would have been a lynch party out for [Greenspan] if he hadn't done something - led by a lot of people on Wall Street," Mr. Kasriel says.
The Fed's action is seen as beneficial not only to Americans, but also to people worldwide. "It tells investors worldwide, the Fed will cut interest rates more in the future," says Michael Cosgrove, an economist at the University of Dallas.
It's hard to tell how much the rate cut will boost spirits. In much of the world, the mood has become decidedly negative.
In the US, the Conference Board posted the largest one-month drop since January in a consumer confidence index the research organization maintains. Wall Street was especially frightened by the collapse of a large, Connecticut-based hedge fund, Long-Term Capital Management.
Gloom is prevalent, too, in crisis countries from Indonesia to Russia. The International Monetary Fund, which holds its annual meeting in Washington next week, is reportedly putting together a multibillion-dollar loan package to rescue Brazil from financial pressures as soon as an election this weekend has passed.
The World Bank, in a special report, said Asia's financial turmoil could get worse. After a decade of prosperity, millions of Asians are likely to be pushed into poverty, and the climb out of poverty will be halted temporarily for millions of others, it said.
"Deep recession has exposed millions of children to hunger," said Jean Michel Severino, a World Bank vice president.
Among Fed policymakers, the action was probably controversial. "I bet it was a spirited discussion," Kasriel says.
Fed watchers guess that at least three of the 18 officials at Tuesday's meeting argued against a bigger interest-rate cut at this time. Still, even dissenters may have ultimately voted in favor of the small cut, so as not to present the world with a divided Fed when the minutes of the meeting are released in five weeks.
The Fed policymakers had to make a choice between a domestic economy that is purring along at a comfortable pace and a world economy that is sputtering.
"The action was taken," the Fed explained in a statement, "to cushion the effects on prospective economic growth in the United States of increasing weakness in foreign economies."
"They want to calm people down," says David Hale, an economist with Zurich Kemper Investments Inc. in Chicago.