Weakened Economy Looks to Fed Cuts

The Federal Reserve meets this week as evidence piles up that the U.S. economy, already weak before the Sept. 11 terrorist attacks, is perilously close to recession.

Many economists believe that the U.S. already is there and predict the central bank policymakers will cut interest rates for the ninth time this year when they meet Tuesday.

Many economists are expecting another half-percentage-point reduction, a relatively aggressive move that would reduce the key federal funds rate, which influences borrowing costs across the economy, to its lowest level in more than 39 years.

The Fed, along with the world’s other major central banks, acted quickly in the wake of the attacks to pump liquidity into the financial system and reduce borrowing costs. The reason it can afford another rate cut this aggressive is that prices are under control, analysts said.

But Christina Romer, a professor of economics at UC Berkeley, said the Fed might cut by only a quarter-point because of previous rate reductions and the improved performance of the stock market in the last week. After four weeks of declines, the Dow Jones industrial average marked its biggest weekly percentage gain since 1984.

“If stock prices kept plummeting, I’m sure they would be much more aggressive,” said Romer, an expert in monetary policy.

Even a modest cut could help the economy, Romer said.

“The only kind of effect it would have in the short run is on perception,” she said. “People are nervous, and just seeing the Fed doing something could have a direct effect on spending.”

One thing the Fed policymakers will have on their side when they meet this week is a lack of pressure from inflation. “The fact that inflation is not a concern means the Fed can really focus on the hit to the economy,” said Tom Gallagher, a political economist for New York-based International Strategy and Investment Group. Gallagher is expecting the Fed to cut interest rates a half-percentage point to help boost consumer confidence.

Some analysts believe that a half-percentage point, or 50 basis points, has already been factored into the market. So they believe that the Fed will have to do the unexpected--cut rates by a more aggressive 75 basis points--to fuel a market rally.

“If they lowered less than 50 basis points, the market’s going lower. If they lower 50, that’ll be in line with what the market is thinking. If they lowered 75, it would be favorable,” said Graham Tanaka, president of Tanaka Capital Management, which oversees about $175 million in assets.

Consumer confidence data will be on Fed Chairman Alan Greenspan’s radar screen as he assesses the economic fallout of the attacks because it was consumer spending, which drives two-thirds of economic activity, that helped keep the slowdown earlier this year from becoming a full-blown downturn.

The University of Michigan’s final consumer sentiment index fell in September to 81.8, its lowest level in nearly eight years, from 91.5 in August. The September reading was cut from a mid-month estimate of 83.6.

Meanwhile, new data to be released today show that business confidence too has faltered since the attacks. A poll of 198 executives shows that U.S. businesses scaled back planned budget increases for computer-related spending after Sept. 11.

Executives said they expect to increase information-technology spending an average of 3.7% over the next 12 months, down from an expected increase of 7.2% in August and 18% in September 2000, according to a study by CIO magazine.

Many economists have said the attacks that destroyed the World Trade Center and damaged the Pentagon may have tipped the U.S. economy into a recession, as airlines slash tens of thousands of jobs and worried consumers pull back on spending. That means an even longer slump in technology spending.

The Fed has slashed interest rates eight times this year by a total of 3.5 percentage points. Currently, the Fed funds rate is 3%, its lowest level in more than seven years.

The Fed’s most recent move came on Sept. 17, the day financial markets reopened for the first time since the attacks. U.S. central bankers cut rates a half-percentage point after a conference call.