Fed Is Aiming for Stabilization With Rate Cut
In normal times, an emergency cut in interest rates by the Federal Reserve might ignite a gleeful upsurge in the financial marketplace.
It also might be expected to spur new borrowing, and spending, to help the economy.
But Monday’s Fed move to cut short-term rates by half a percentage point had a different goal, experts said: It was a signal to the world that financial authorities were moving to control a panicky situation--a signal designed more to stabilize the economy than to spark a dramatic swing in the public mood, or stoke more borrowing.
“It’s a dark night, and you’re scared, and it’s good to know somebody down the hall has a light on, and you can go to them for help,” said Carl Weinberg, chief economist with High Frequency Economics in Westchester County, N.Y.
Of the Fed action, he added: “I don’t think they were looking for an instant fix.”
‘A Limited Effect’
Economists frequently say it takes six months or longer for lower interest rates to stimulate the economy, as the benefits of cheaper credit gradually ripple through. Lower rates tend to encourage greater borrowing and inspire mortgage refinancing, putting more money in the hands of consumers and businesses.
The Fed action was the eighth cut this year and brought the central bank’s key short-term rate to 3%. Banks cut their prime lending rate, a benchmark for business and consumer loans, from 6.5% to 6% Monday in tandem with the Fed move.
The prime has dropped from 9.5% early this year, yet the drop has failed to significantly boost the economy.
But to the Fed, that is now beside the point, analysts said.
As a means of getting the public to borrow more, another rate cut “has a limited effect,” said Larry Horwitz, senior economist at Decision Economics in Boston. “I think people are much more focused on, No.1, their jobs, and No.2, the terrible amount of uncertainty and fear that is out there now.”
Analysts said that the paramount economic issue in the wake of disaster was one of confidence, an intangible that affects prices in financial markets and sales in auto showrooms and shopping malls. Monday’s move was seen as part of an ongoing effort to address damaged confidence in the U.S. economy, a problem that has worsened in the aftermath of last week’s terrorist attacks.
“I think it’s mainly coming as a confidence-building measure,” Horwitz said of the Fed move. “Lower interest rates are not likely to help the economy much in the short term. But as a show of support--that the Fed will do what is necessary to keep the financial machinery greased--it was very important.”
Even before last week, the future was clouded by concerns of a precarious economy. Measures of consumer confidence and levels on the stock market had been sliding. In the disaster’s aftermath, some of those concerns have been heightened, and new ones have emerged. The crisis raises the possibility of a large, indirect hit to the economy if nervous consumers choose to hold onto their incomes rather than to make big-ticket purchases of homes, cars and other expensive items.
On top of that, it is slamming particular companies and industries, such as financial interests based near the World Trade Center, insurance firms, airlines--and tourist destinations that depend on airline travel for their lifeblood.
Some analysts were optimistic that the economy will respond to lower rates sooner than later. They said the Fed’s latest cut symbolized that government officials in effect were minding the store, an important message.
Moreover, that message dovetails with news that the government will be infusing more cash into the economy, through spending both for disaster relief and as part of the military response to terrorism.
“The hope is that people will say the Fed is doing what it can . . . that even though public confidence may be lower based on what’s happening right now, that their outlook on the future will be more positive,” said Mario De Rose, a market strategist with the Edward Jones firm in St. Louis. “I think the market was looking for something, and consumers were looking for something.”
A Matter of Time
While some criticized the Fed’s timing, arguing the cut should have come later in the day, others viewed it as revealing the Fed’s deep level of concern. Normally, officials would be wary of easing rates on a day that a deep dive in the markets was widely expected, and prospects that the Fed could reverse it were dim.
“In ordinary times, they would have preferred to wait for the dust to settle and then do it and turn the psychology of the market,” said James Glassman, U.S. economist with J.P. Morgan & Co. in New York. “The fact that they did it means that somebody realized that anything that could be done to bolster confidence is a plus.”
At the same time, Glassman argued that the American public’s psychology in the near future might prove different than generally expected; that the public might take a defiant stance and spend money rather than cut back out of fear.
“Either people panic and retrench and get very cautious, or they respond differently, which I think is possible--but many people think is nutty,” Glassman said.
