The Dwindling Power of Rate Cuts

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October 3, 2001

The Dwindling Power of Rate Cuts

Yesterday the Federal Reserve lowered interest rates for the ninth time this year. The federal funds rate, the key tool of monetary policy, is now 2.5 percent — below the level of inflation. The Fed was hoping it would buoy investor and consumer confidence, and given the markets' current psychology, it probably had little choice. The stock market did respond well to the move.

Still, it is becoming clear that the nation's economic woes are not going to be fixed simply by continual rate-cutting. The attacks of Sept. 11 caught the Fed at just the wrong time. Under the leadership of Alan Greenspan, it had slashed rates by three and a half percentage points between January and August in an attempt to juice up a sagging economy. The effects of rate cuts take a while to kick in, and the nation should have been starting to feel their influence right now. But the terrorist attacks took a big, one-time bite out of the economy that lower lending rates cannot fully address. Quick but careful action from Congress and the Bush administration is going to have to do the rest.

Cuts in the short-term federal lending rate can help businesses offer consumers easier credit, but they cannot make businesses invest in growth when sales are down, or make consumers suddenly worried about their jobs and portfolios decide to go shopping. Only intelligently targeted government spending — or, to a lesser extent, broad-based temporary tax cuts — can stimulate purchasing.

Cutting the federal funds rate also cannot lower long-term interest rates if the markets have no confidence in the stability of the federal budget. Worries that the Bush tax cut would aggravate future deficits are one reason that long-term rates stayed stubbornly high for much of this year, although they have fallen since the terrorist attack pushed a recovery further into the future.

Markets have been looking to the Fed's announcements for soothing words of reassurance — the perception, if not the reality, of a guaranteed safety net. Had the Fed not cut rates again, markets would have slumped and faith in the Fed's commitment to keep pumping up the economy would have dwindled. So the rate cut made some sense, but it will hardly be enough by itself.

Mr. Greenspan seems to believe that monetary policy changes may be sufficient to guarantee a recovery. Though he endorsed President Bush's irresponsible tax cuts earlier in the year, he has stopped short of recommending a fiscal stimulus now. Meanwhile, the Fed is running out of room. If it raises rates anytime soon, markets will react with fury. But there is a limit to how low short-term rates can go, and the Fed may want to save its remaining ability to maneuver for a time when cuts will have more impact.

Mr. Greenspan might have saved the country from at least some of its current problems if he had not thrown his substantial influence behind the Bush tax-cut plan, which drastically reduced government revenues over the long run while providing little in the way of stimulus right now. Perhaps that is the reason he is counseling the government to go slowly on any economic stimulus package. But the nation's economic problems require more help than his own monetary tools can provide. It is time for Congress and the president to act, and for Mr. Greenspan to concentrate on his own brief.

http://www.nytimes.com/2001/10/03/opinion/03WED1.html?ex=1002772800&en=ce1bc2dcd1972402&ei=5040&partner=MOREOVER

-- Martin Thompson (mthom1927@aol.com), October 03, 2001

Answers

All I can say is: typical New York Times story. They understand tax incentives to the same degree that Donald Duck would understand Einstein's Theory of Relativity.

-- JackW (jpayne@webtv.net), October 04, 2001.

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