NEWS ANALYSIS : Politics, Rate Outlook Tie Clinton to Fed Chief : Economy: President would face difficulty in replacing Greenspan. Lower rates expected this summer.

When White House Chief of Staff Leon E. Panetta suggested during a recent appearance on a Sunday morning television talk show that it was time for a reduction in interest rates, he was privately but quickly upbraided by Treasury Secretary Robert E. Rubin.

The Clinton Administration has a longstanding policy, Rubin reminded Panetta, of not publicly criticizing the Federal Reserve Board and its handling of interest rates.

Such support from a Democratic Administration helps explain why Federal Reserve Chairman Alan Greenspan, a Republican holdover, appears likely to be reappointed by President Clinton when his second four-year term expires in March.

Despite ominous signs that the economy is slowing just as the presidential campaign cycle is beginning to gear up, Clinton and his senior economic advisers seem to believe that there is no real alternative to living with Greenspan.

Replacing him in the midst of next year’s presidential campaign could have a disastrous impact in the stock and bond markets, where Greenspan is seen as an anti-inflation hawk. Almost any Clinton nominee would face a difficult and highly political confirmation process in the Republican-controlled Senate.

And the most compelling reason for keeping Greenspan may be that the central bank’s chairman finally seems poised to do just what the White House wants--cut interest rates.

Most analysts say they believe that the Federal Reserve, seeking to pull the economy back from the edge of recession, will reverse course sometime this summer, possibly as soon as a two-day strategy session of the bank’s policy-making Open Market Committee that opens today.

That would mark the end of the Federal Reserve’s preemptive strike against inflation, during which it lifted short-term interest rates by three percentage points from February, 1994, to February of this year. By the end of 1995, many analysts are predicting, the central bank may have cut rates by as much as one full percentage point.

Analysts are split on whether the Fed will move now. But most agree that if it does not act this week, it almost surely will cut rates by 0.25 or 0.50 of a percentage point at the next meeting in August. The rate reduction would be the first since September, 1992.

If Greenspan and the fiercely independent central bank cut rates, it will be because of worrisome signs of a slowing economy--not out of allegiance to Clinton. Yet for once, the economic and political pressures on the Federal Reserve are moving the central bank in the direction Clinton would like to see it go.

“Politics and economics are coming together now,” said Allan Meltzer, an economist at Carnegie Mellon University in Pittsburgh, Pa., and a longtime observer of the central bank. “Today, the political thing to do is also the right thing to do for the Fed.”

Clearly, the Federal Reserve has accomplished its primary goal over the past 18 months: slowing an overheated economy to head off a potential surge in inflation. After the economy raced to a 4.1% growth rate in 1994, it slowed to a 2.7% pace in the first three months of this year.

The nation’s jobless rate has begun to edge up as well, to 5.7% in May, and corporate layoffs seem to be picking up speed. Regional data also shows that job growth has declined in virtually every part of the country; employment in May fell in 29 states.

The slowdown is largely the byproduct of the central bank’s preemptive strike against inflation. Fearful that it would be too late to stamp out inflationary pressures if it waited for increased prices to appear in the monthly economic data, Greenspan’s Fed began to raise rates in the winter of 1994, as soon as economic growth gathered steam.

Greenspan and his allies argued that uncontrolled economic growth would inevitably lead to rising prices. Their goal, sustainable economic growth with stable prices, was what economists like to call a “soft landing”--a slowdown, but not a recession.

Since it first acted on Feb. 4, 1994, the Fed has doubled its benchmark federal funds rate--the rate banks pay each other for overnight loans--from 3% to 6%. That has led to higher borrowing costs for U.S. homeowners, consumers and businesses, while pinching such economic sectors as the automobile and construction industries, which are particularly sensitive to interest rate hikes.

Federal Reserve officials seem satisfied that their strategy was successful in heading off inflation, and they appear willing to shift their attention back to economic growth.

The big question is whether they are too late.

That is a critical issue for the Clinton White House. In theory, a rate cut in July or August should provide perfect timing for the President’s reelection hopes. The impact of such actions usually do not show up in the economy for about six months. Thus the benefits from a rate reduction in the summer of 1995 would become apparent around the beginning of 1996.

Of course, that means that a decision by the Federal Reserve to wait until winter before cutting rates could be disastrous for the economy--and for Clinton.

“They can’t wait much longer” if they want to avoid a recession, argued David Wyss, an economist at DRI-McGraw Hill, an economic consulting firm based in Lexington, Mass. “It doesn’t make much difference whether they move in July or August, but they have to move this summer.”

Even if the Fed moves soon, success is not guaranteed. Monetary policy is a blunt instrument and it is often difficult for central bank officials to steer the economy with any precision. Already, economists are warning that the economy actually contracted in the second quarter of 1995, which ended June 30. Most say they believe that growth will rise again in the third and fourth quarters but will remain weak.

“The economy has slowed more than expected,” cautioned Jerry Jasinowski, president of the National Assn. of Manufacturers and an economist who has long been critical of Federal Reserve policies.

Fed officials are increasingly worried about the threat of a recession, which could cost the central bank public support for its inflation-fighting efforts. While Greenspan has sought to remain inscrutably confusing in his public pronouncements, Vice Chairman Alan Blinder--a Clinton appointee--has made it clear that he now sees the threat of recession to be more serious than the threat of further inflation.

Other Fed officials are tentatively speaking up as well. “A recession is not the most likely outcome,” said Robert P. Forrestal, president of the Federal Reserve Bank of Atlanta. But, he added, “the possibility of a recession has increased.”

Even if the Fed moves too sluggishly in coming months, the Clinton Administration may still keep Greenspan at the helm of the central bank. Greenspan has influential allies beginning with Rubin, who is now clearly Clinton’s most influential economic adviser.

Rubin and Greenspan, who have breakfast together once a week, have developed a strong relationship, sources said. Rubin is particularly grateful that Greenspan was a strong supporter of the Administration’s bailout of Mexico. Greenspan lobbied hard on Capitol Hill for the aid package.

“Rubin thinks that Greenspan has done a good job. They are friends. They work well together,” said one source. “You can draw your own conclusions from that on where Rubin’s mind is on reappointing Greenspan. So I would say that if a decision had to be made tomorrow, [the Administration] would probably reappoint him.”

Still, officials warned that if the economy sours by winter and Federal Reserve policy seems to conflict with White House goals, some Clinton political advisers might push for Greenspan’s ouster.

“Election politics will matter a lot,” said one Administration official. “A lot will depend on how the economy does in the third and fourth quarters. If the economy picks up, if we get growth with moderate inflation and consumer confidence goes up, that will take care of any questions.

“If that doesn’t happen, then you could get into a situation where you have [political] people in the White House saying we need a scapegoat.”

For his part, Greenspan, who turns 70 in April, isn’t saying whether he wants another term. But he has always said that the chairmanship of the central bank is his dream job. And, as a vigorous man without children, grandchildren or other family responsibilities--Greenspan has maintained a long relationship with NBC news correspondent Andrea Mitchell but is not married--he has little to distract him from his public life.

In a fine piece of political irony, Greenspan may win reappointment in part because one of his biggest congressional critics, Sen. Alfonse M. D’Amato (R-N.Y.), is chairman of the Senate Banking, Housing and Urban Affairs Committee, which would have to approve Clinton’s choice. While D’Amato is so unhappy with the Federal Reserve that his committee probably would reject anyone else nominated by Clinton to head the central bank, he would have trouble persuading a majority of his committee and the Senate to oppose Republican Greenspan.

For his part, Clinton--whom D’Amato has pursued relentlessly over the Whitewater controversy--probably would find it difficult to impossible to get the nomination of any Democratic economist through the Banking Committee. Thus Clinton might find it expedient simply to renominate Greenspan.

The White House has already had to abandon its plan to nominate Treasury Department economist Alicia Munnell to a vacant seat on the central bank’s seven-member board of governors because Republicans on the Banking Committee thought her too liberal. Instead, the Administration gave Munnell a seat on the President’s Council of Economic Advisers.

As a consequence, Greenspan, appointed by President Ronald Reagan and reappointed by his successor, George Bush, may outlast his third President, extending his hold on U.S. interest rates into the 21st Century.