Greenspan Signals Interest Rate Cut

Federal Reserve Board Chairman Alan Greenspan, warning that the “virulent” global economic crisis is getting worse and poses a growing threat to the United States, hinted broadly Wednesday that he will support a cut in interest rates as early as Tuesday.

Greenspan’s remarks, coming after a drumbeat of pleas by economists at home and overseas for the Fed to lower rates and fuel global growth, triggered a dramatic run-up on Wall Street and in Latin American markets.

The Dow Jones industrial average soared 257.21 points, or more than 3%, to 8154.41, with investors interpreting Greenspan’s shift in position as a sign that the world’s most influential central bank was finally taking aim at the global crisis.

Lower rates would make it cheaper for consumers and business to borrow money and make purchases, good news not only at home but for struggling Latin and Asian nations that depend heavily on selling goods to the U.S. market.

Slashing U.S. rates even modestly would also tend to reduce upward pressure on rates in overseas economies and make more credit available, helping to spur at least some spending in those largely moribund economies.

But there was no sign Wednesday of a coordinated action on interest rates by the Group of Seven top industrial nations. Such a broad step, urged by leaders in Asia and elsewhere, is seen as necessary to have a convincing impact on the international economy.

“I think we know where we have to go,” Greenspan told the Senate Budget Committee in characteristically vague terms. “We don’t underestimate the problem.”

While saying that the global financial chaos had not yet caused “significant, underlying weakness” in the overall U.S. economy, he predicted that fallout from overseas was “likely to intensify” domestically in coming months.

The Fed’s policymaking Open Market Committee is scheduled to meet Tuesday, when it will consider reducing U.S. rates for the first time since early 1996.

“It was a pretty clear signal that he’s going to cut rates,” said Gerald D. Cohen, senior economist with Merrill Lynch in New York. “A lot of his comments showed a clear bias toward easing rates.”

For months, economists have warned that severe global financial troubles--which first hammered currencies in Asia and have spread to emerging economies throughout the world--would inevitably take a toll on the United States.

As recently as mid-August, however, Fed officials still believed that the hard-charging U.S. economy stood as much risk of overheating with a new round of inflation as of hurtling downhill, a victim of the global pressures.

Increasingly, “contagion” from the overseas turmoil has battered U.S. export-oriented manufacturers, including many California high-tech enterprises with markets in Asia. In addition, growing financial pressure in Brazil and elsewhere in Latin America increasingly worries U.S. officials who fear that the problems could spread throughout the hemisphere.

On Wednesday, Greenspan said he has changed his mind since mid-August, and he now considered it less probable that the U.S. economy will overheat.

“Since then,” he said, “deteriorating foreign economies and their spillover” had increased chances that a “slowdown in the growth of the American economy will be more than sufficient to hold inflation in check.”

That conclusion has large implications for interest rates. Fed officials would be loath to cut them if they still considered inflation a significant danger.

As is customary, Greenspan refrained from explicitly forecasting his plans for interest rates, and he left the Fed room to hold off acting next week. But analysts were struck by his grim description of the worldwide financial trauma and his assessment of the risk that it could spread to the stronger, advanced economies.

“We have to bring the existing instabilities to a level of stability reasonably shortly to prevent the contagion from really spilling over and creating some very significant further difficulties for all of us,” he said.

There have been “few signs” that the financial crisis has subsided, he said, and national leaders “have to be especially sensitive to the deepening signs of global distress.”

Referring to Fed officials, he said, “I do not think we underestimate the severity of the problems with which we are dealing.”

And he chose to reiterate a point he made several weeks ago, that America could not be a haven from the furious financial pressures advancing throughout the world: “It is just not credible that the United States, or for that matter Europe, can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress.”

An interest rate cut would come in the federal funds rate, which banks charge one another for overnight loans. The rate, currently pegged at 5.5%, could be eased by one-fourth of a percentage point or perhaps half a point, analysts said. The Fed’s most recent action on rates, in March 1997, was to nudge the federal funds rate up one-quarter of a point.

Merrill Lynch’s Cohen said a rate cut “helps the U.S. economy directly and indirectly.”

But there is strong resistance to such action in Europe, whose economies are trying to bring interest rates in line with one another before the Jan. 1 introduction of a common currency, the euro. Greenspan has said no such coordinated international rate cut is in the works.

Nonetheless, Greenspan’s comments Wednesday sent markets soaring in Latin America as well as New York. Brazil’s main market index jumped 11%, helped also by signs that an international aid package was imminent.

International Monetary Fund Managing Director Michel Camdessus said Brazil’s leaders had “intensified their open and constructive dialogue” with the IMF about a credit line said to total at least $25 billion.

Brazil would draw on such a fund to bolster its foreign currency reserves in the face of ongoing capital flight. Weakness in Latin America, a critical export market for the United States, is a big worry in Washington.

The drumbeat for a reduction in U.S. interest rates next week seemed to gain an important adherent Tuesday when William McDonough, president of the Federal Reserve Bank of New York and a member of the Open Market Committee, told reporters: “I can assure you that as I go into that meeting I will continue to be very aware of potential weakness in our economy.”

McDonough’s remarks were widely seen as reflecting Greenspan’s views. Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis, said, “Greenspan told us in unambiguous terms that he will be cutting interest rates next Tuesday.”

WILL IT HELP?: A cut won’t end the global economy’s woes, but it can’t hurt, Tom Petruno writes. D1

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The Reaction

How the Dow index fared:

Open: 7,899.52

Close: 8,154,41.

Change: +257.21

Time of Greenspan speech