WASHINGTON DISPATCH
Rate Cuts Didn't Spur Businesses By Peter G. Gosselin Times Staff Writer
November 6 2002 WASHINGTON -- As political Washington spends today picking at the bones of the congressional election to figure out how much will change, economic Washington is poised to do something very similar. If surveys of prominent forecasters are correct, the Federal Reserve will cut its benchmark federal funds rate from its current 41-year low of 1.75% to 1.5%, or perhaps 1.25%. The action almost certainly will be hailed as just what the staggering U.S. economy needs. The only problem: The new cuts are unlikely to do much good, and could do some harm. That's partly because the Fed already has cut rates a lot, and low interest costs have worked much of the magic they can. In the last few years, consumers have replaced one-third of all the country's cars and financed or refinanced almost all of its houses. Banks are unlikely to offer 30-year mortgages at much below 5.75%. Automakers are going to be hard pressed to beat the interest-free financing they already offer. "Nobody can claim that Fed rate reductions haven't given consumer spending a big boost," said David M. Jones, a Denver economic consultant and commentator. In fact, some worry that the boost is distorting the economy. Two-thirds of last quarter's growth was due to auto sales. And that still hasn't been enough, largely because the central bank has been unsuccessful with the other actor in the nation's economic drama: business. And therein lies a clue to why its new rate cuts are unlikely to make much difference. To appreciate how unsuccessful, see the accompanying chart of bank loans to business. The way the system is supposed to work, when the Fed raises rates, lending falls; when it cuts rates, lending climbs. But in the last few years, the very opposite has happened. "The Fed hasn't been able to convince businesses to borrow from banks, or anybody else for that matter," said Mark Zandi of Economy.com, a West Chester, Pa., forecasting firm. Some who advocate a new round of Fed rate cuts contend that the central bank simply did not cut far enough and fast enough to get the results it wanted and now must finish the job. They may have a point. After getting a roaring start by slashing the funds rate 11 times in 2001, Fed policymakers stopped in their tracks and have not budged for almost a year. One way to gauge the dimensions of their pause is to compare it with the Bank of Japan's performance in the early 1990s. The Bank of Japan has become symbolic of bad central banking because it raised rates just as Japan's stock market and economy were coming apart and was slow to reverse course and begin cutting. Americans have taken no end of comfort from the notion that their central bank acted very differently. But if one dates the start of the Japanese bust to the collapse of the Nikkei stock average in 1990 and the start of the U.S. bust to the free fall of the Nasdaq index in 2000, the performances of the two central banks begin to look a lot more alike. Roughly three years into their respective troubles, U.S. and Japanese policymakers had each shaved between 4.5 and 4.75 percentage points from their benchmark interest rates. The only difference was that Fed officials acted faster, then stopped. "They did the right thing; it just wasn't enough," said Allen Sinai, chief global economist with Decision Economics Inc. in New York. Sinai and others say that more rate cuts, and substantially steeper ones than the Fed is likely to approve today, eventually will return the economy to good health. But the fact that the cuts to date have not done the trick -- and have made almost no difference to American businesses -- suggests two distinctly darker possibilities. The first, and by now generally conceded, point is that this is no ordinary economic slowdown. It is one caused by the bursting stock market "bubble" that was a dream for businesses while it was ballooning and has been a nightmare since it popped. The second, and more heretical, notion is that there's not much the Fed or any central bank can do about this kind of slowdown. The only solutions are huge tax cuts or simply waiting it out. "We're in the middle of a great experiment that asks whether an aggressive central bank can stop a big recession after a big stock market bubble," said John H. Makin, an economist with the conservative American Enterprise Institute. "We don't know the answer yet, but if it's no, people's faith in central banks as buffers against serious recession or depression is going to be badly shaken," Makin said. In this view, Fed Chairman Alan Greenspan and his colleagues made a fundamental mistake about the late 1990s, and especially about corporate America's spending spree on new technology. "They thought that technology and the capital-spending boom was driving the stock market up when it was the other way around," said Robert J. Barbera, chief economist with ITG/Hoenig in Rye, N.Y. "The surging stock market was providing the funds to fuel the capital-spending boom." So what should the Fed do? On this point, economists' advice is a little disconcerting: Cut anyway. "If a patient is ill, you give him medicine," Sinai said. "It may do very little good, but you give it anyway." Unless, of course, it's the wrong medicine. If you want other stories on this topic, search the Archives at latimes.com/archives. For information about reprinting this article, go to www.lats.com/rights.
-- Marta Russell Los Angeles, CA http://www.disweb.org -------------- next part -------------- An HTML attachment was scrubbed... URL: <../attachments/20021106/64309ea7/attachment.htm>