Fed to the rescue - but in time?

Rate cut aimed at calming markets and consumers. But a supertanker-size economy takes time to change course.

Will it do the job?

The Federal Reserve's dramatic drop in interest rates this week will likely have a powerful psychological impact on the listing US economy.

It was intended to reassure people and policymakers alike that the Fed is on alert - and that the nation shouldn't panic about an economy that has declined with almost inexplicable speed.

In that sense, the half-point rate cut may help stabilize the stock market, revive consumer spending, fuel bank lending, and keep manufacturers producing such things as fenders and fiber-optic cable.

But the deeper impact on the economy - of this rate cut and others that are expected - is far less definitive. It normally takes six to nine months for an interest-rate change to work its way through the economy. By that measure, the Fed's last interest-rate increase, in May, has yet to be fully felt.

At the same time, the current downturn has come so quickly and for so many reasons - high oil prices, weakening overseas economies, a moribund stock market - that some say concerted action to prevent a recession should have come sooner.

"The Fed is behind the curve and needs to cut rates much further to get the economy back on track," says Brian Wesbury, chief economist of Griffin, Kubik, Stephens & Thompson Inc., a Chicago investment house.

While most economists still expect the economy to avoid recession, Mr. Wesbury sees such a mild contraction as likely.

But certainly the unexpected move by the Fed on Wednesday sends a powerful message, both at home and abroad.

Stock markets in London and Paris cheered the Fed action, rising yesterday especially for high-tech shares. Amid worry that Japan's economic recovery is fading, nations worldwide are eager for signs that America's hunger for imports won't slow.

At home, too, the message was reassuring: "The Fed won't permit the US economy to go down the tubes," says Bruce Steinberg, chief economist of Merrill Lynch, the nation's largest brokerage.

Stock prices surged, at least for a day. And the promise of lower debt payments should cheer consumers.

"People had sort of panicked," says Alicia Munnell, a former member of President Clinton's Council of Economic Advisers. Christmas retail sales were weak, and worse was feared ahead.

Even Washington got a reassuring hint. Don't panic, the Fed in effect said to Congress. The economy will be doing fine, and you don't need to spend so much money to revive it.

Alan Greenspan "wants to get ahead of a stampede and try to divert it," says Harald Malmgren, a Washington economic consultant.

The "stampede" consists of growing congressional enthusiasm for spending aimed in part at reviving a softening economy - and assuring reelection in 2002.

While Mr. Greenspan is thought to be open to tax cuts, he has long seen extra spending as wasteful of national resources.

Another target of the Fed missive was industry. An index of manufacturing activity based on monthly surveys by the National Association of Purchasing Management was down to its lowest level since 1991, a recession year.

Banks, too, have been tightening up on lending. The Fed prodded them to reopen the money spigot by cutting its federal funds rate - the rate banks charge one another on overnight loans. Some banks have now cut loan rates.

Many Fed watchers anticipate further interest rate cuts ahead, starting when Fed policymakers meet next in Washington Jan. 30.

The Fed's action was unusual in that it was taken between scheduled policy meetings, with a conference call. The last time the Fed did this was in October 1998, when the turmoil of the Asian financial crisis was accentuated by devaluation of the Russian ruble and failure of a major hedge fund in the US.

To slow the US economy and dampen inflation prospects, the Fed has raised interest rates six times since June 1999 by a total of 1.75 percentage points.

The Fed's policy worked. Housing and consumer spending slowed. Economists expected slowing - but not recession.

But then, "all the momentum went out of the economy in November and December," as Charles Blood, chief strategist for Brown Brothers Harriman, a New York investment firm, puts it.

Recession talk spread like mold on an overly ripe peach. It was led by economists in the camp of President-elect Bush, worried about a rocky start to his presidency.

Bad news piled up: corporate bankruptcies, dotcom failures, rising layoffs, slower capital spending by business, and power shortages in California.

All this helped push the Fed into emergency mode. Its action was bigger and faster than anticipated.

In the Wall Street excitement Wednesday, bond prices fell swiftly. The Fed, in effect, had declared victory in its battle against inflation - a battle bond owners want to be sure is won.

Analysts are unsure if the stock recovery will last - given growing concern about corporate profits.

But Mr. Blood notes that in the years since 1945, when a down year in the stock market has been followed by monetary easing, the average price appreciation for the Standard & Poor's 500 index has been 16.7 percent for the following year.

(c) Copyright 2001. The Christian Science Publishing Society

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