Next move by the Fed is anybody's guess

SUNDAY OUTLOOK

September 17, 1995|By John E. Woodruff

Economists increasingly agree that the Federal Reserve has at last pulled off an elusive "soft landing," wringing inflation out of the economy without driving it into recession. Can this condition of no inflation and no recession be sustained? What forces will work for and against the Fed as it seeks to maintain the delicate balance? Will the Fed cut interest rates again?

Dennis A. Starliper

Managing director and treasurer, Provident Bank

Certainly the inflation numbers continue to come in under the markets' expectations. Hours worked, factory utilization, all the things that suggest inflation down the road, also appear to be very calm. But this gives me the impression that the Fed has engineered a much gentler but much more prolonged fall than we had been assuming.

Now, when I look for something that is going to lead the growth forward from here, I'm not sure I see it. Will it be housing? No sign of that. Will it be consumers? Consumers are under a tremendous load of debt, and additions to consumer debt were very heavy over the past year or so. Will it be autos?

I can see continued growth at perhaps 1 or 1.25 percent for the rest of this year and perhaps into the first quarter of next year. But I'm at a loss to see where the force will come from to drive growth next year, unless you assume in some general way that the election year will have an impact. I don't see a crash coming, but I don't share the euphoria that calls for not only low inflation but also economic growth of 2 percent or more.

Douglas Kinney

Chief economist, Baltimore Gas and Electric Co.

There was concern earlier this year that maybe the Fed had overtightened, but the danger of recession seems to have passed.

The Department of Commerce is instituting a new method of reporting gross domestic product, and it seems likely the new method will show an actual decline in GDP in the second quarter of this year even though the old reporting methods do not. The declines in industrial production in the second quarter were due to inventory excesses, and companies appear to be working those off smoothly. There are still some excess inventories to be worked off in some industries, especially automobiles, but there is a widespread assumption that those can be worked off without cutting production back to levels that would induce a recession.

The key question is what will consumers do? Consumers took on considerable debt in the second quarter. That borrowing helped

to work off the inventories, but it also left household balance sheets pretty strained. That could make it harder to complete this inventory adjustment now. My assumption is that after the consumer experiences of 1991 and 1992, people will be reluctant to take on the inordinate amounts of debt that were so common in the 1980s. People feel less confident of their employment, and the danger that further corporate downsizing will threaten your own job will be not in the backs of people's minds but in the fronts.

The Federal Reserve is tough to outguess in this mixed environment. My hunch is they might drop rates another quarter of a point at the September meeting. The chairman, Alan Greenspan, is up for reappointment, and next year is a presidential election year. This may be a time when they will feel it's prudent to err on the side of supporting some growth.

Bill Cheney

Chief economist, John Hancock Financial

The year has worked out almost exactly as the Fed would have wanted, though the slowdown may have been concentrated in the second quarter more than anyone foresaw. Inflation has behaved better than anyone expected.

In our forecasts going out a couple of years, we don't see either a recession or much inflation, but the farther out you try to forecast, the more chance you take that some unforeseeable event will come along to upset the trends. In 1990, just as it seemed the Fed had managed the soft landing, there was Saddam Hussein, the Gulf War and a lot of worries over oil prices.

Until recently, I would have bet on the Fed to cut interest rates one more time this year, but now the economic indicators are becoming mixed and the chances may be more like 50-50. The chances are that there will be another cut, but it could come in November, or it could come early next year. I think the Fed still wants to see a "neutral" federal funds rate, which means a "real" federal funds rate of about 1 or 2 percent, over and above inflation. So if inflation stays around 3 percent, where it is now, the fed funds rate has to come down to 5 percent or so.

And there is still one great unknown that the Fed has to take into account, which is the budget debate in Washington. Our forecasts assume that nothing from Washington will affect the ,, deficit enough to move interest rates this year. If in fact Congress and the president did make cuts that moved long-term interest rates down this year, that would further encourage the Fed to ease short-term rates.

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