[PEN-L:31589] pushin' on a string?

["Ian Murray" <seamus2001@xxxxxxxxx>]

washingtonpost.com
Fed Seems Headed For Interest Rate Cut
By John M. Berry
Washington Post Staff Writer
Saturday, October 26, 2002; Page A01


With the U.S. economic recovery losing steam and the outlook clouded by the
possibility of war with Iraq, a volatile stock market and corporate
accounting scandals, Federal Reserve officials appear likely to cut
short-term interest rates before the end of the year, perhaps as soon as at
their next policymaking meeting.

The officials' concern, expressed in recent public speeches and private
conversations, is not that the economy is headed for another recession -- a
"double-dip" after last year's. Rather, some Fed officials worry that the
economy has virtually stopped growing over the past two months and will grow
only weakly for an extended time, making it vulnerable to a shock such as a
protracted war in Iraq that could cause oil prices to go up and U.S.
consumers to curtail their spending.

Fed officials are scheduled to meet Nov. 6 -- the day after Election Day --
when they could reduce their 1.75 percent target for overnight interest
rates. However, rather than act immediately after the election, some might
prefer to wait until their next meeting, on Dec. 10.

At their last meeting, on Sept. 24, a majority of the central bank's top
policymaking group, the Federal Open Market Committee, left the target
unchanged, but two members dissented in favor of a rate cut.

Most economic data since have indicated weaker rather than stronger growth,
including a sharp 5.9 percent drop in new orders for durable goods in
September, which the Commerce Department reported yesterday. The two
dissenters, Fed Governor Edward M. Gramlich and Robert D. McTeer Jr.,
president of the Dallas Federal Reserve Bank, therefore probably still favor
a rate cut. It also is likely that other members of the Open Market
Committee would have preferred to lower rates last month but deferred to Fed
Chairman Alan Greenspan's choice not to.

Given that background and the weakness of the data, Greenspan probably would
have little difficulty achieving a consensus for lowering the target by
either a quarter or a half percentage point. One important factor is that
officials see no sign of inflation problems. Another is that while some
analysts have questioned whether reducing the already low target further
would stimulate growth, Fed officials believe it would help.

The October employment report to be released Friday could affect the
decision on interest rates. And should Greenspan decide that a rate cut is
still premature, a majority of the committee would go along with him, with
some dissenters.

The majority's statement after the last meeting said the committee still
believed that economic growth would pick up but that "considerable
uncertainty persists about the extent and timing of the expected pickup in
production and employment owing in part to the emergence of heightened
geopolitical risks." That uncertainty, officials believe, is a key reason
that businesses are postponing investment decisions.

There is also considerable concern that the corporate accounting scandals
and the legislative and regulatory responses to them are causing business
executives to act more conservatively than usual in making commitments to
invest and hire. Yet another worry is that growth is weakening in both
Germany and Japan, perhaps hurting the market for U.S. exports.

"Looking forward, the economy remains a fragile balancing act between
resolute consumers and skeptical businesses," Cathy E. Minehan, president of
the Boston Federal Reserve Bank, said in a speech last week. "So far, the
consumer's optimism has more than offset business pessimism. But how long
can the consumer hold out? The risks here seem firmly on the downside."

In her New England region, Minehan said, the outlook "remains highly
uncertain and forward-looking indicators have failed to improve," suggesting
that "expansion is unlikely in the next six months."

In a similar vein, the president of the St. Louis Federal Reserve Bank, Will
iam Poole, said in a talk Wednesday that the economy is "recovering all too
slowly from last year's recession."

The Commerce Department is expected to report Thursday that the economy grew
in the July-September period at an annual rate of 3 to 4 percent, after
adjustment for inflation. That would mean the U.S. economy grew about 3
percent since September 2001.

That growth has produced only small increases in payroll employment this
year. Meanwhile, the number of private-sector jobs remains about 1.2 million
lower than it was a year ago.

Many forecasters expect economic activity to increase at no more than a 2
percent annual rate in the final three months of the year, with slow
improvement in 2003. With productivity -- the amount of goods and services
produced for each hour worked -- rising strongly, the growth predicted in
those forecasts could go hand in hand with a rising unemployment rate.

Many Fed officials have assumed that if consumer spending kept rising,
businesses -- which cut way back on investments in new plants and equipment
during the recession -- would resume spending. Such spending did pick up
slightly in the second quarter of this year and probably increased again in
the third. However, those gains have not been enough to lift the economy
onto a healthy growth path, in the view of many Fed officials.

Economist Janet L. Yellen, a former Fed board member now at the University
of California at Berkeley, said she "had expected investment spending to
revive and lead to growth that was at least high enough to keep unemployment
from growing."

"Now I'm not sure," Yellen said. "With the possibility of war with Iraq
looming, my impression is that firms are reluctant to make new investments."

The Fed's latest survey of nationwide economic conditions found that
manufacturing activity "decreased or grew more slowly in September and early
October" in most of the country. "Tough," "stagnant," or "sluggish" were
some of the words factory executives used to describe the business
conditions they faced, the survey summary said. In particular, the survey
found "a reluctance of manufacturers to undertake capital spending."

Tony Raimondo, president of Behlen Manufacturing Co., a Nebraska-based metal
fabrication firm that employs about 1,300 people, is head of a small
business committee for the National Association of Manufacturers. Recently
Raimondo said that companies such as his remain very cautious about
investment decisions.

"We have to have the uncertainties clear up. It is extremely difficult to do
any forecasting in this climate," Raimondo said. What is needed is more
certainty about whether demand for products will increase and for banks to
become more willing to extend credit to smaller firms such as his, he said.

Some analysts have raised two questions about cutting rates. First, since at
1.75 percent the Fed's target is not far from zero, should the Fed lower it
any more unless it is absolutely necessary? Second, would a rate cut help
spur growth?

Officials believe that if a rate cut is needed, they should not delay it
because the target is already so low. They also believe that a rate cut
would help the economy, though they are not sure how large the impact would
be because the target has never been so low in the decade and a half that it
has been used as a policy tool.

Former Fed vice chairman Alan S. Blinder agreed with both views.

"If the problem is really the war with Iraq, which is what really worries
me, then a rate cut would help but not be a cure," Blinder said in an
interview. The impact from a cut might or might not be smaller than if the
current target were higher, he said, but "I don't see any reason to suppose
that monetary policy loses its punch at very low interest rates."

Yellen agreed that a rate cut would have an impact. Even if the current
target level is providing some stimulus to the economy, as many Fed
officials have said, it may be "not stimulative enough," she said.