Fed Apparently Trying to Lower Interest Rates : Economy: It pours money into the banking system in reaction to credit shortage, a sputtering recovery.
Reacting to renewed signs of a sputtering economic recovery and a persistent reluctance by banks to make loans, the Federal Reserve pumped money into the nation’s banking system Tuesday in a move that appeared aimed at pushing interest rates lower.
Economists said that the infusion of capital was expected to reduce the benchmark federal funds rate for overnight loans between private banks by a quarter of a percentage point to 5.5%, the lowest level in more than a decade.
The Bush Administration has been urging the Fed to lower interest rates to keep the recovery moving, and expectations of an imminent reduction intensified last Friday when the Labor Department reported an unexpected loss of 51,000 payroll jobs in July.
In addition, Fed Chairman Alan Greenspan has expressed concern in recent weeks that extremely slow growth in the nation’s money supply suggests a continuing credit shortage that could smother the recovery and tip the economy into another recession.
But the timing of the Fed’s move, which occurred at midday Tuesday on the East Coast, caught private economists and financial markets by surprise.
Stock prices surged, with the Dow Jones industrial average gaining 38.24 points to close at 3,027.28. Interest rates on long-term bonds declined, suggesting that institutional investors see little danger that lower short-term interest rates will fuel inflation by making money more plentiful.
“This is welcome, if a bit overdue,” said Jerry Jordan, an analyst with First Interstate Bancorp in Los Angeles.
“Until late last week, the conventional wisdom was that the Fed would sit tight,” said economist Bruce Steinberg of Merrill Lynch Capital Markets in New York. “Now, there is a reversal of expectations--and you had some good reasons for that.”
Several economists predicted that the reduction in the federal funds rate will be followed by more interest rate cuts as the Fed tries to head off a possible new recession by loosening its grip on the nation’s credit supply.
Some analysts speculated that another rate cut could occur as soon as Aug. 20, when the Federal Open Market Committee, the Fed’s policy-making board, meets to assess current economic conditions. At that time, some believe, the Fed could move to bring the discount rate, which has stayed at 5.5% since it was last cut on April 30, to its customary level of at least a half-point below the fed funds rate.
“They don’t talk themselves into taking only one step like this after four months of inaction,” First Interstate’s Jordan said.
In lowering banks’ cost of obtaining funds, the Fed hopes to induce them to reduce a variety of short-term interest rates for businesses and consumers and thus stimulate borrowing and economic demand.
The Fed’s efforts to direct fiscal policy involve two key interest rates. It influences the federal funds rate by increasing or reducing the cash reserves held by private banks. Such moves generally cause the rate to rise or fall by a quarter of a percentage point.
The Fed can take more direct action by raising or lowering the discount rate--the rate it charges on direct loans to commercial banks. Discount rate adjustments generally occur in half-point increments and require the formal approval of the Fed’s seven governors.
Since July, 1990, when the recent recession began, the Fed has acted 10 times to nudge the fed funds rate down from a high of 8.25%. The new level of 5.5% would be the lowest since the rate bottomed at 5.4% in 1977.
Starting last December, the Fed began reducing the discount rate also. The rate has fallen from 7%, the level it had been since early 1989, to the present 5.5%. Another reduction would take the rate to 5%.
“If we get another weak retail sales report next week and inflation seems to be holding steady, then the Fed could follow with a discount rate cut on Aug. 20 or shortly after,” said Irwin L. Kellner, an economist with Manufacturers Hanover Bank in New York. “But, if they don’t do it then, they may not do it for a while. This Fed has a history of moving cautiously.”
The Fed does not publicly announce or discuss changes in the federal funds rate, which become known by the reaction in the private market. The Fed chairman has authority to direct such moves on his own, but a known consensus-builder like Greenspan is generally assumed to have taken an informal poll of other Fed governors and the five Federal Reserve regional bank presidents who sit on the Open Market Committee.
Shortly before the Fed’s move to reduce interest rates in the United States, the central bank of Germany signaled its intention to raise its discount rate in an effort to head off the feared inflationary effects of German reunification.
In other economic developments Tuesday, the Labor Department reported that labor productivity for all non-farm businesses rose at an annual rate of 1.9% during the second quarter, well below the historic rate of increase in productivity in the early stages of a recovery.
Manufacturing productivity improved at an annual rate of 3.6%, the department said. That showing, although respectable, is well below the 8.5% rate of improvement recorded during the first quarter after the steep recession of 1982.
The National Assn. of Realtors, meanwhile, said that sales of existing homes improved sharply in the second quarter. Home sales rose 3.5% over the same period in 1990 to an annual pace of 3.8 million units and were 12.4% higher than during the first quarter.
Productivity (Southland Edition, A13)
Non-farm business productivity, percent change from previous quarter at annual rate, seasonally adjusted. 1991 (2nd qtr. 1991): +1.9% Preliminary Source: U.S. Dept. of Labor