Fed Official Rejects Calls for More Rate Cuts

A member of the Federal Reserve Board, providing an unusually forthright signal of the central bank’s intent, said Wednesday that the U.S. economy is clearly improving and rejected calls for further interest rate cuts to spur the recovery.

John P. LaWare, a governor of the board, told members of the Senate Banking, Housing and Urban Affairs Committee that it is not yet clear the stimulative effects of past interest rate reductions have worked their way fully through the economy. And he warned that another cut could fuel inflationary fears.

“Our projections for the growth rate for the balance of the year are optimistic,” LaWare said, adding that the nation’s stubbornly high unemployment rate should begin to subside in coming months.

LaWare’s upbeat forecast was immediately challenged by committee Chairman Donald W. Riegle Jr. (D-Mich.).

“More and more people are feeling quite desperate” about their inability to find work, Riegle said. “I’m asking you to take another look” at interest rates.

LaWare responded with a polite, but unmistakable dismissal. “We take a look every day, senator,” he said.

Efforts to cut interest rates would be futile in stimulating the economy unless consumers recover their confidence and begin to spend more money, LaWare said. And he emphasized that it is beyond the Fed’s power to persuade people, already worried about losing their jobs, to increase their purchases.

“The question is whether further reductions in short-term rates will affect the psychology of consumers,” he said.

LaWare noted that the great risk of trying to cut interest rates further is the danger of “reigniting inflation.” Long-term interest rates remain unusually high, reflecting the financial markets’ skepticism about the nation’s ability to win a permanent victory in the battle against inflation, he said.

LaWare and other financial regulators told the committee that the drop in short-term interest rates has helped banks enjoy record profits in the first quarter of the year. Bank earnings rose to $7.6 billion during the quarter, up from $5.5 billion during the same period a year ago.

When Riegle challenged LaWare, citing rising unemployment figures, the Fed governor responded with the observation that unemployment often keeps rising as a recovery is under way because jobless people who had stopped looking for work resume their search.

Riegle was joined in the call for Fed action by Sen. Bob Graham (D-Fla.), who said that the country suffers from a deficit of hope.

“People are raising basic questions about where . . . their family’s future is going to be,” Graham said. When interest rates were even lower early in the year, the housing industry boomed, he said. “There was a period of hope when rates were down,” he told LaWare, and suggested Fed action to bring rates down again.

But LaWare again demurred, saying that there is no assurance lower rates will significantly promote consumer spending and a resurgence of business activity. Unless consumer demand is ignited, LaWare said, “there is a waiting game” for the economy to be revived.

He insisted that the uncertainties of consumer spending make it too risky for the Fed to cut rates and possibly spark a serious new round of inflation.

“A stable price environment is the healthiest thing for the economy,” he said.

LaWare also said that the recession may have been prolonged in some parts of the country because of unusually restrictive lending policies by banks. Some businesses may have been denied loans that they should have been granted, he said, adding to the credit crunch that slowed the recovery.

Because of previous bank problems, the federal regulators have been urging bankers “to strengthen their credit standards--a process that in some cases may have gone too far,” LaWare said. “Whether caused by overly critical supervision or by bank managements that were too conservative, the tightening may have had counterproductive results,” he said.