Falling Interest Rates Unlikely to Jog Economy

Interest rates are falling sharply, but the drops may be too little--and too late--to stave off recession or dramatically shore up ailing companies and banks, at least for the next few months, economists said Wednesday.

The Federal Reserve Board moved this week to cut key lending rates, including a move on Wednesday to drive down the federal funds rate, the rate banks charge each other for overnight loans. That, plus the Fed’s reduction on Tuesday of its key discount rate, should have a ripple effect on the cost of everything from home equity loans to corporate borrowing. The moves are intended to boost consumer and corporate spending, and, consequently, bolster the faltering economy.

However, consumers--worried about recession and war and already overextended with credit card and other debts--are unlikely to boost spending enough to give the economy a quick shot in the arm regardless of more attractive borrowing rates, economists said.

Corporations, suffering slow sales and already heavy debt loads, are scaling back their borrowing needs. And banks, hard hit by credit-quality problems, are not anxious to push loans on borrowers who are increasingly less credit worthy.

The end result is that the economy will still slow dramatically in the next several months. But the lower rates may help shorten the slowdown in the long run, leading to a modest recovery in the second half of 1991, economists said.

“Is this enough to revive the economy? No,” said John Lonski, senior economist with Moody’s Investors Service in New York.

Lonski predicts that unemployment will rise over the next four months, inflation will remain relatively high and economic growth will come to a grinding halt.

Moreover, if the Persian Gulf crisis escalates into war, the financial carnage could be more severe and lasting. Economists believe a war would have the effect of driving commodity prices--particularly the price of oil--into the stratosphere, which would increase inflation and drive a stake into the heart of the expected economic recovery.

“If shooting starts, all bets are off,” said J. Jerry Jordan, senior vice president and chief economist with First Interstate Bank in Los Angeles. “Commodity prices would rise sky high, stock and bond prices would plunge, airlines and transportation companies would have liquidity problems. Metals, paper, rubber and glass companies would all get hurt. People would probably stop servicing their debts.”

Added David Hale, chief economist of Kemper Financial Services in Chicago: “We are in a recession that will last at least until the spring. And if we get into a shooting war, it could hurt the economy a lot. There is a lot to . . . pray for.”

If there is a peaceful solution in the Middle East, the economy should start to bounce back next spring and summer, Jordan said.

Still, if anyone is hoping for a short-term fix, they are likely to be disappointed largely because consumers are worried about what might happen.

“This is not a case of (people reacting to) what they believe, it is what they fear,” Jordan said. “It is a case of protecting themselves in case the worst happens--just so they can survive.”

Nevertheless, the Federal Reserve’s moves will help reduce economic pressures on industry, experts said.

What the Fed did, in cutting the discount rate and pushing down the federal funds rate, was reduce the rates that banks must pay to borrow. Banks, presumably, will pass those cost savings on to their corporate and individual customers.

However, banks don’t need to pass the savings on immediately. Many experts, in fact, expect them to drag their feet to boost their profits, currently squeezed by souring domestic and international loans.

Eventually, though, market pressures and competition will force banks to cut their prime lending rate. That will reduce the rates many companies pay for credit, as well as cut rates on home equity loans that are tied to changes in the prime rate.

That should improve the financial condition of companies and consumers, who find they need to shell out less of their monthly income to service their debts. Corporate profits, however, are expected to be hurt by reduced consumer spending.

Normally, too, lower rates would spur more borrowing, but that is not likely to happen this time, bankers said.

“Bankers are looking at how badly the economy is sinking and whether the loans we’re making today are going to be more risky six months from now,” said Bram Goldsmith, chief executive of City National Bank in Beverly Hills. “So we are being more prudent and cautious.”

The corporations most likely to need money are those that are least credit worthy and least likely to entice bankers, experts added. Healthy companies, meanwhile, are expected to reduce borrowings as they cut inventories to account for reduced consumer demand.

In the long run, however, low rates do tend to spur the economy by encouraging borrowing, spending and investment. And once the uncertainties relating to the Persian Gulf crisis are past, many believe that the Fed’s moves to cut rates will have the desired effect.

“Everything they are doing is positive, but you can’t open the Dom Perignon yet,” said Joseph Wahed, chief economist at Wells Fargo Bank in San Francisco. “It is too early in the game and there are too many uncertainties.”