Fed Funds Rate Cut; Deepening Slump Feared

The Federal Reserve Board cut interest rates Friday in response to signals that the nation’s economy is deteriorating at a more rapid pace than previously believed, and a handful of commercial banks quickly followed suit by lowering their prime lending rates.

The Fed eased its benchmark federal funds rate--the interest rate for short-term borrowing by commercial banks--by a quarter of a percentage point to 7.25% immediately after the Labor Department reported that the jobless rate had risen sharply to 5.9% in November and that 267,000 jobs had been eliminated during the month.

After the Fed’s action, several banks cut the rate that they charge their best corporate borrowers by a quarter of a point to 9.75%. Analysts expect most major banks to make similar cuts next week, and they said that the prime rate could drop as low as 9.5% by Christmas.

Coupled with a revised loss of 178,000 jobs in October, last month’s decline caused the worst two-month drop in employment since the depths of the 1982 recession. November’s jobless rate was the highest in three years and provided proof to many economists that another recession has begun.

“We are in a recession, and I think, when historians look back, they will determine that it began in August or September,” said Gordon Richards, chief economist at the National Assn. of Manufacturers.

Top Bush Administration officials, deeply concerned by the worsening unemployment numbers and by the growing consensus among private economists that a recession has begun, quickly hailed the Fed’s action as a bright spot on an otherwise bleak economic front.

“The size of the decline in employment was not expected, and that seems to confirm that economic growth will almost certainly be negative in the fourth quarter,” Michael J. Boskin, President Bush’s chief economic adviser, said in an interview.

“We are pleased to see the interest rate cut,” Boskin added. “Lower rates should lead to improvements in the economy in 1991.”

Friday’s fed funds rate adjustment was the third such reduction in six weeks, and it was the second time this week that the Federal Reserve has used one of its monetary policy tools to ease its grip on the economy.

Earlier this week, the central bank reduced the reserve requirements it imposes on commercial banks, freeing up about $14 billion for additional consumer and commercial lending. The move was made in response to mounting pressure from the Bush Administration to take steps to help alleviate a growing credit shortage in many regions of the nation.

Many economists believe that the Federal Reserve will lower the fed funds rate to 7% before the end of the year and that it could drop below that level early in 1991.

“The economy has taken a turn for the worse, unemployment is quite high and banks are under stress, so I think the Fed will move again,” said Robert Hormats, vice chairman of Goldman, Sachs & Co. in New York. “I think the Fed has the mandate to ease again.”

The quick rate reduction following release of the unemployment statistics suggested that Fed Chairman Alan Greenspan is no longer as concerned about the threat of inflation as he appeared to be immediately after the Aug. 2 Iraqi invasion of Kuwait.

Earlier this fall, the Fed had been moving more cautiously, out of fear that lowering rates at a time when oil prices were soaring would only worsen inflation.

But gathering evidence that the economy is experiencing a sharp downturn and that higher oil prices are not causing prices of other goods to rise significantly appears to have convinced the Fed that it has the leeway to move more aggressively.

“I think the Fed has acted very prudently . . . . I don’t think there is any worry now that inflation will get worse because of lower interest rates,” said Lawrence A. Kudlow, senior economist at the New York investment firm of Bear, Stearns & Co.

“And I think that, with lower interest rates, a calmer Mideast situation and lower oil prices, we could see consumer confidence and consumer spending rebound early next year,” Kudlow added. “That could really shorten this recession.”

Separately, the Fed said that consumer credit grew by just 2.4% in October, down from September’s 4.6% increase. Economists said that the low October rate was another sign that consumers are retrenching in the face of a worsening economic outlook.