NEW YORK -- Money is cheaper, but will anyone buy?
Trying to jump-start a stalled economy, the Federal Reserve Board lowered yesterday the pivotal discount rate, and major banks followed by cutting their prime rate. But the moves stirred only mild enthusiasm in the financial markets and raised questions among economists about whether a slight reduction in borrowing costs would improve business conditions, and if so, when.
Reflecting the muted response among investors, long-term rates, over which the Fed has little control but which are important to business, barely budged. And the quarterly
auction for 10-year Treasury notes went badly, as had the three-year auction that was held Tuesday. Stock prices moved up slightly on modest volume.
The discount rate is interest the Fed charges member banks for short-term loans. The prime rate, once described rates banks charged their best customers, is now used by banks as a base rate for corporate loans.
Among the banks that lowered their prime were Citicorp, BankAmerica Corp. and Morgan Guaranty Trust Co.
The discount rate was lowered from 5 percent to 4.5 percent, its lowest level since 1973, while the prime went from 8 percent to 7.5percent, a level not witnessed on a sustained basis since 1977.
While both rates have little practical significance, they serve as indicators of Fed and bank policies and are tied to other borrowing costs, including consumer and seasonal business loans.
Still, the long-running joke in the financial community is that each reduction in rates -- and this year there have been five cuts in both the discount rate and the prime -- is merely a chance to not borrow at a cheaper price.
Banks have declined to make loans, and consumers, worried about job security, have shunned borrowing.
"Because there is so much debt already, there is little appetite for more, so lower rates are unlikely to increase borrowing or lending," said Henry Engler, an economist with Chemical Bank.
Other recent rate cuts have had little impact on credit card interest rates, among the most commonly used methods of borrowing. Rates on mortgages and car loans have come down, but availability has tightened as lenders take a tougher look at credit histories and require higher down payments.
"For the situation we are in to turn around, what is required is time," Mr. Engler said. "As a result, we're unlikely to see strong activity soon."
Many opinions exist about the long-term impact of yesterday's rate cuts.
In testimony before Congress yesterday, Paul Boltz, a T. Rowe Price economist, criticized the rate cut, saying the economy has begun to expand and a reduction in rates would likely stimulate inflation.
"The recession, as grim as it was, did not have an effect on core inflation," Mr. Boltz said later. "A lot of services seem to be unimpressed by the recession. Medical inflation continues to barrel along; so does entertainment inflation, like the cost of cable television. There are a lot of areas where price pressures remain strong."
Mr. Boltz also called rate cuts an inappropriate solution to the current slowdown. "It won't solve problems like commercial overbuilding from the '80s, change the export picture or change the consumer's desire to save more," he said. "These are big fundamental forces the Fed may only change marginally."
A more positive view of the rate cuts was given by Geoffrey Moore, head of Columbia Business School's Center for Business Cycle Research. He has studied recessions dating back centuries and plays a key role on the National Bureau of Economic Research's authoritative recession dating committee.
The correlation between an upturn in the economy and the direction of changes in the prime rate, Mr. Moore said, has been tightly tied to the duration of the recovery. With yesterday's move, he said, the expansion, which he believes began in May, will extend at least until mid-1993, and maybe longer if rates come down again.
Interest rates, Mr. Moore noted, typically serve as a lagging indicator of economic conditions, continuing to fall well after a recovery begins. Contrary to widespread perception, the current recovery is not very different from prior recoveries in terms of many significant indicators, including industrial production, employment and personal income, Mr. Moore said.
"When you compare things to a year ago, they don't look good because you are comparing them to the top, but compare them to where they were in spring or summer and they are moving up," he said.
Leonard Lempert, an economist with Statistical Indicators, a Massachusetts forecasting firm, said that "the first five or six months of a recovery are really the same as five or six months of a recession. When the recovery is as sluggish as this one is, you are not very far above the later months of the recession, but the thing that is crucial [is that] you are going up, not down."