Easing the Credit Crunch

December 07, 1990

The Federal Reserve Board's latest move to ease the credit crunch is further acknowledgment that the economy is in recession. Fed chairman Alan Greenspan conceded last week that the country is in the midst of a "meaningful downturn" but avoided use of the "R-word" until it is confirmed by two straight quarters of negative growth.

By easing reserve requirements for commercial banks, the Fed gave a shot in the arm to a sorely pressed sector of the financial community. Whether banks will actually ease the squeeze on would-be borrowers or put their newly released funds into Treasury securities to improve their earnings and balance sheets is a matter of conjecture. But the Fed made clear its main concern is a shortage of loan money. It said it wanted to provide "added incentive to lend to creditworthy borrowers, countering the impact of the recent tightening of credit conditions."

The credit crunch is widely blamed for worsening what President Bush has labeled a "serious slowdown." Both corporations and individuals in many parts of the country have encountered difficulty in getting loans because many banks, with plenty of nudging from federal regulators, have drawn away from the high-flying business practices of the 1980s.

In itself, the Fed's action is as much symbolic as substantive. In turning to its least-used tool for stimulating the economy, the nation's central bank is signaling that further moves to reduce interest rates may be expected in an effort to keep the recession relatively moderate and short-lived. The Fed reportedly has been encouraged in this direction by fairly weak inflation pressures, except for rising oil prices. Even in this sector, the increases triggered by the Iraqi crisis have been far less than those experienced twice in the 1970s.

Any actions taken by the Fed at this juncture are bound to affect White House preparation of new economic forecasts and the fiscal 1992 budget due in January. Because numerical deficit targets have been abandoned as non-operative, the Bush administration may be tempted to boost federal spending if it determines that fiscal rather than monetary remedies are needed to combat this recession. It is at that point that the Fed should play a restraining role.

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