Fed action may soften recession: economist

December 05, 1990|By Ross Hetrick | Ross Hetrick,Evening Sun Staff

NEW YORK -- The Federal Reserve's policy of loosening the reins on the nation's money supply may soften the blows of the coming recession, according to the financial economist for T. Rowe Price Associates Inc.

"This is going to be a unique downturn, said Paul W. Boltz, vice president and financial economist for Price, the Baltimore-based mutual funds and investment firm.

"This will be the first in the post [World War II] era preceded by a steady easing of monetary policy," he said.

The Federal Reserve is the nation's central bank and can affect national interest rates by changing various banking requirements.

In just such a move, the Federal Reserve yesterday said it was reducing the requirements for banks to hold a certain percentage of their deposits as reserves.

The central bank said it is cutting the 3 percent reserve requirement on non-personal time deposits with maturities of less than 18 months, which are mostly corporate certificates of deposit. The Federal Reserve also is eliminating a reserve requirement on Eurocurrency liabilities.

Boltz made his comments yesterday to Price's annual press conference and luncheon held at the Time & Life building in New York.

The Federal Reserve's easy-money policy is one reason Boltz is predicting a mild to moderate recession, lasting six to nine months, starting at end of this year. He expects the unemployment rate will not go over 7 percent.

"We do not foresee bankruptcies sweeping through the business sector, an outcome some believe is predetermined by excessive borrowing during the 1980s," Boltz said.

Despite the large increase in corporate and personal debt, Boltz said, the pace of borrowing was not noticeably out of line with earlier decades when viewed in relation to economic growth. "In the aggregate, businesses and households should be able to manage their debt service as they have during other postwar recessions," he said.

Much of the consumer debt is largely reflected in the purchase of "bigger and better homes" and corporate debt "always tends to rise as a share of GNP during expansions," Boltz said.

"The big borrower of the 1980s was the federal government, and we do not expect a bankruptcy there," he said.

However, Boltz said the economy could have been plunged into "another Great Depression" if the federal government had not picked up the massive losses of the thrift industry. "With little debate on whether the bailout should proceed, Congress wisely decided not to repeat one of the key errors of the 1930s: letting the banking system go bust," Boltz said.

Even though there is a downturn in consumer confidence and real income growth has slowed and will probably soon turn negative, the "classic ingredients" for a severe recession are missing now, he said. "Business inventories are not critically out of line with sales, the unsold stock of new houses is not awesome, the Federal Reserve is not tighting credit and the dollar is weak," Boltz said.

Another favorable factor is that some countries remain healthy. "Japan and Germany will continue to enjoy positive economic growth in 1991, albeit slower than this year as adjustments are made to higher energy prices," he said.

Last year Boltz had predicted a slower economy, but no recession in 1990. This forecast seemed to be coming true earlier in the year as growth was slowing. "We were achieving the fabled soft landing," he said. "Then the economy got clobbered by Iraq's invasion of Kuwait."

"Now as we near the end of 1990, the question of the hour is not whether there will be a slowdown, but rather how severe it will be."

Boltz warned that his new prediction could be blown off course if there is another shock similar to Iraq's invasion of Kuwait. "A long shooting war in the Middle East, another surge in oil prices, an unwillingness of foreign investors to finance the U.S. current account deficit or the collapse of a major bank here or in Japan comes to mind," he said.

"But weighing these possibilities, we still think the recession will not become an uncontrollable downward spiral," Boltz said.

Despite the expected downturn in the economy, stocks and bonds are still a good, long-term investment, said George J. Collins, president and chief executive officer of Price.

"While investors should not count on a quick market recovery to recoup recent losses, those with a long-term investment horizon should stick with their plans," Collins said. "Experience teaches us that investors with a diversified, long-term strategy do better over time than those who try to restructure their portfolio every time the wind blows from a different direction."

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