Fed Reluctant to Cut Rates Again : Economy: The central bank reportedly doubts ability of lower interest levels to fuel recovery and fears resurgence of inflation. Setback to White House seen.

The Federal Reserve Board has virtually ruled out further interest rate reductions this year, despite the economy’s persistent sluggishness, according to senior officials at the agency.

Sources at the Federal Reserve said that the board doubts the ability of lower rates to fuel the economy, fears the resurgence of inflation next year and is wary of some potential long-term political ramifications of further interest rate reductions.

The decision by the independent central bank is certain to disappoint the White House, which has been counting on the Fed to cut interest rates and bail out the country--and President Bush--from the lingering slump before the 1992 election campaign begins in earnest. The Fed sets monetary policy through its control of the money supply and its ability to influence commercial interest rates.

With tax and budget policy virtually paralyzed by the record federal budget deficit, Congress and the Bush Administration have been unable to push through spending programs or tax cuts that would invigorate the economy. The President recently decided against campaigning for a package of stimulative tax cuts at least until next February.

As a result, White House economic policy has been reduced to little more than publicly urging the Fed to cut interest rates. Treasury Secretary Nicholas F. Brady and Bush’s chief economic adviser, Michael J. Boskin, have both pushed hard for further reductions in the last few weeks.

Senior Administration economic policy-makers declined to comment Monday on the Fed’s decision.

At an internal policy meeting last week highlighted by a lengthy and intense closed-door debate over the direction of the economy, Fed officials effectively agreed that, “even if we see a bad month or two, we will ride it out” without further cuts, one source said. The Fed will move again “only if things get bad for several months and really go into a free-fall,” the source said.

Last week, the Fed lowered its benchmark discount rate--the rate it charges commercial banks for short-term loans--by a half point to 4.5%, its lowest level in 18 years. It also slashed the federal funds rate--the rate banks charge each other for overnight loans--by one-quarter of a point to 4.75%. But Fed officials have now decided that “we have gone down just about as far as we can go,” sources said.

The decision not to cut rates further stems, in part, from a growing fear within the Federal Reserve about political pressures that it will face from the White House during the upcoming presidential election, sources said.

At last week’s meeting of the Fed Open Market Committee--composed of seven members of the Federal Reserve Board and five of the Fed’s regional bank presidents--some officials warned that, if rates are lowered further now, they might have to be raised next year to hold down inflation--provided the long-awaited economic recovery gains momentum.

But raising rates in the middle of a presidential election would be extremely difficult. It would be much easier, Fed officials argued, to forgo another rate cut now in hopes of delaying rate increases as long as possible during the expected recovery next year.

“There has been a lot of discussion, not just in the last meeting but in the last few meetings, about what happens when we have to raise rates again,” a Fed source said. “That’s one reason (the Open Market Committee has) talked about . . . not lowering rates (further) now, because it will be hard to raise them again next year.”

The concerns underscored the Fed’s deep-seated fears about a resurgence of inflation next year. Fed officials believe that there is a delay of three to six months between the time rate reductions are made and their effect on the economy is felt. Consequently, they fear that another move on interest rate policy now will hit the economy just as it is gaining momentum, leading to higher prices.

Officials acknowledged, however, that the Fed may be forced to change course and move more aggressively if the economy deteriorates badly. “You’ve got to remember (that) we have said we wouldn’t go lower before,” a Fed official said.

But a growing number of Fed officials are expressing doubts about their ability to use interest rate policy to influence the direction of the economy. Sources said that senior Fed policy-makers are frustrated that interest rate reductions over the last year have failed to have the usual result--helping to revive the economy by stimulating spending.

Interest rate reductions have traditionally been a key strategy for combatting recession. By reducing the cost of borrowing, they tend to stimulate consumer purchases of such high priced items as houses and cars, which in turn stimulates production and encourages more investment by business. The sources privately concede that lower interest rates may not be the right medicine for an economy that is heavily burdened by public and private debt.

With corporate America and private individuals still working off the massive debts built up during the frenetic 1980s, few companies or consumers are in the mood to borrow, even at low interest rates. What’s worse, the nation’s ailing banks, seeking to beef up their profit margins, have been unwilling to respond to the Fed’s reductions by lowering the rates they charge their customers.

“There is a lot of restructuring of debt going on in the economy right now; everyone is unwinding the silliness that went on in the 1980s,” a Fed official said. “So I think there is a recognition at the Fed that the balance sheet adjustments will take longer and will delay the recovery more than we expected.”

As a result, even those officials who believe that the economy is too sluggish are not convinced that further rate cuts by the Fed would do much good. “I must say that I don’t think monetary policy can do much right now,” admitted one senior Federal Reserve policy-maker.

“It is probably too strong to describe it as a panic (inside the Fed Open Market Committee) over the economy,” another Fed source said. “But there was a sense in the meeting that, boy, this (recovery) is not coming in like we thought.”