Can the Fed Stop the Recession?

May 01, 1991

Having been rebuffed by its major economic partners, the United States has decided to go it alone in lowering interest rates to fight a recession that threatens to be longer and deeper than the Bush administration wants to admit. Whether the Federal Reserve Board will rue its third half-percent cut in the discount rate in four months, to a level of 5 1/2 percent, will depend on several factors:

What if the reduction has as little effect as preceding cuts? What if inflation returns later this year? What if lower rates discourage the foreign captial needed to finance U.S. budget and trade deficits?

Such considerations explain, in part, why the Fed has been bickering internally and why Wall Street, at least initially, shrugged off the drop in interest rates it supposedly wanted. The fact is that U.S. economic clout on the world scene is much diminished and the wisdom of its economic policies is widely doubted. Neither executive-branch Republicans nor legislative-branch Democrats have much stomach for fiscal policies that would make a good global impression. So the politicians have left it to the Fed to try to set things right.

For the present, the Fed is putting its emphasis on fighting recession rather than combating inflation. Reductions in interest rates were made, it said, "in light of continuing weakness in economic activities, especially in the industrial and capital goods areas and evidence of abating inflationary pressure." President Bush, who has to worry about re-election next year, welcomed the Fed move, remarking that "we are the largest economy in the word, and if ours is robust and growing that benefits everyone else in my view."

This is an egocentric view more applicable to gulf war victories than to current economic realities. At this week's meeting of the G-7 central bankers and finance ministers, not only the Germans and the Japanese but the British and Canadians were quick to say they would manage their own economies, thank you, in light of their own internal circumstances. They hardly looked to the debt-ridden Americans for leadership.

Indeed, Canadian Trade Minister Michael Wilson said that "if you push down [interest] rates in an unnatural manner, you're just going to have short-term benefits." Mr. Wilson observed that rich countries have been telling poor countries for years that fiscal policies should be designed to take the pressure off interest rates while monetary policies should be used to fight inflation. It was clear he thought the U.S. should follow its own advice.

If there is any comfort to be gleaned from the Fed action, it is that an adroitly timed increase in liquidity could jump-start an economy that is sputtering like the 1991 Orioles. At a later point, the Fed will have the more difficult task of keeping the motor running without overheating. It can expect little help from the White House or Congress.

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