Greenspan set to shrivel rates with magic wand

The Economy

January 14, 2001|By WILLIAM PATALON III

Alan Greenspan has pulled off many an economic miracle as chairman of the Federal Reserve Board.

Remember the Crash of '87, when, as the newly minted Fed chief, Greenspan stepped off an airplane in Dallas to learn that the Dow had dropped 508 points? He averted a crisis by boosting liquidity, and the expansion continued for another three years.

In 1994, with the U.S. economy accelerating and inflation worries spiraling, the Greenspan-led Fed boosted interest rates enough to engineer a "soft landing" - and in 1995 the central bank cut rates fast enough and deep enough to avert a recession and continue the expansion.

And in 1998, when the so-called "Asian contagion" and the collapse of the Long Term Capital Management Hedge Fund threatened to swamp the U.S. economy, Greenspan worked his economic magic yet again. The Fed reduced interest rates three times in a short stretch, dodging still another recessionary bullet and ultimately nurturing the expansion into record territory.

And now another chapter of the Greenspan economy-management manual is being written. In hopes of slowing an economy whose breakneck growth pace was threatening to stoke inflation, the Fed boosted short-term interest rates six times from June 1999 to May 2000, and waited until this month to reverse course. Some economists and investment experts now fear that Greenspan was too aggressive in raising rates and waited to long to start cutting them.

The rate increases crushed stock prices, vaporized consumer confidence and took the economy from a 5.2 percent pace in the first half of last year to a 2.2 percent pace in the third quarter - and perhaps lower still in the fourth quarter.

"In hindsight, it's clear that the final interest-rate increases made in 2000 were overkill, given that inflation was in check, that consumer spending was beginning to slow and that employee cost indices were very, very benign," said Jonathan Murray, first vice president of investments for Legg Mason in Baltimore.

Only time will tell whether that overkill translates into the first U.S. recession since 1990-1991. Although recession talk first surfaced before a holiday shopping season that ultimately was quite lackluster, only in recent weeks have economists acknowledged any real chance of a recession.

With its half-point reduction on Jan. 3, the central bank has shifted into its rate-cutting mode, as policymakers likely figure that there's still time to dodge a recession. Experts say the Fed must cut rates by another three-quarters of a percentage point - bringing the total reduction to 1.25 percent. That will probably happen: The conventional wisdom is that the central bank will announce another reduction immediately after the conclusion of its Jan. 30-31 Federal Open Market Committee meeting.

Most experts believe that such rate cuts will be just what the economy needs. Stocks, for example, had a losing year in 2000. Since 1965, the nine times that the Standard & Poor's 500 stock index has suffered a losing year the index returned an average of 12 percent the next year. But, if the Fed cut interest rates during the 12 months after that losing year, that average annual return jumped to 18.5 percent, said Legg Mason's Murray.

This odd confluence of factors - last year's drop in the S&P 500, the fall-off in consumer confidence and a Fed that's in a rate-reduction mode - may well help Greenspan keep the U.S. economy out of a recession and put it back on a growth track.

If there's been one significant shift in the American economy in recent years, it's that consumer confidence and the health of the stock market are more closely linked than ever. If the Fed's rate-cutting campaign really jump-starts stock prices - there's already evidence that's happening - then consumers could find themselves with a much brighter outlook. And if consumer confidence rises, so, too, will consumer spending, which accounts for two-thirds of all activity in the nation's $10 trillion economy.

If it all plays out that way, Greenspan will have saved the day again - even though many thought he was too heavy on the brakes this time around.

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.