Fed's chief in hot seat

Greenspan faces risk of recession, economic confusion

`Could go either way'

Analysts divided on outlook, factors affecting growth

April 22, 2001|By William Patalon III | William Patalon III,SUN STAFF

Even with four rate cuts already on the books - and more expected to come - the Federal Reserve stands at a pivotal juncture as it attempts to dodge a recession, economists say.

"The risks to the expansion are very high," said Mark Zandi, chief economist for Economy.com in West Chester, Pa. "The probability of a recession this year is about 50-50 - and it really could go either way."

On Wednesday, the Fed surprised economists and thrilled investors by slashing the benchmark federal funds rate by half a percentage point, the fourth time since the start of the year the central bank pared that short-term interest rate by that much.

While the surprise rate cut evoked a near-euphoric response from investors - who gleefully propelled stocks to near-record gains - the newfound aggressiveness of the characteristically cautious central bank has some economists believing that Fed Chairman Alan Greenspan is scambling to shore up an economy that's fading much faster than he ever anticpated.

"The Fed is playing catch-up ball," said Peter Morici, a University of Maryland economist who is also a senior fellow at the Economic Strategy Institute, a Washington think tank. "It raised rates too much in the first place and then waited too long to cut them."

While that's now the conventional wisdom, there isn't a consensus about how the U.S. economy will fare the rest of this year and next. While Economy.com's Zandi says a recession is very possible, though not yet probable, most economists still seem to think the United States will avoid a recesSion for now. Growth will slow for the first, second and third quarters - with perhaps one quarter in which gross domestic product declines - though the country should miss the two straight quarters of declining output that defines a recession.

However, not only are economists and other analysts offering differing forecasts, but they also differ on which factors could influence the outcome.

Jay Bryson, a global economist with First Union Corp. in Charlotte, Va., believes the deep rate reductions have put the economy in better shape than it was just a few months ago.

"The economic data the past two weeks hasn't been all that bad," Bryson said. "There's not the sense of panic there was in December and January."

But portfolio manager John P. Hussman, who runs a mutual fund out of Ellicott City, says the U.S. economy is in much deeper trouble than most realize.

"I think we're [already] in a recession," said Hussman, who runs the Hussman Strategic Growth Fund. "There are numbers - a virtual laundry list of things - that have only occurred during economic recessions." Among them: anemic job growth of less than 1 percent, weak consumer confidence and a National Association of Purchasing Management index that touched its lowest point ever.

The central bank itself is uncertain about where the economy is headed or what else needs to be done. Fed Vice Chairman Roger Ferguson said Thursday that "it is too early to have a strong conviction that the economy is reaching the end of this period of quite slow growth." What's more, he said it's not even clear how low rates must go to restore healthy growth.

After years of enjoying a reputation for near infallibility, Greenspan and the Fed lately have been blamed for the end of the bull market and economic slowdown that took hold late last year. A U.S. growth rate of better than 4 percent - coupled with a robust stock market, relentless consumer spending and a boom in capital spending - spawned inflation fears at the Fed.

The central bank responded, boosting interest rates six times from June 1999 to May of 2000 - a campaign of five quarter-point increases capped off by a half-point coup de grace.

Greenspan compounded this error by ignoring signs of a slowdown, and waiting too long to bring rates back down, critics say.

The impact wasn't immediate but was ultimately severe. Corporate profits eroded. Bad loans multiplied at banks, which cut back on lending. Finally, the tight monetary policy choked off and stalled the two engines that elevated economic growth into a boom: Stock prices and capital spending.

Now, as it strives to restore growth, the Fed will discover some crucial problems that rate cuts won't resolve, experts say. Take the telecommunications portion of the capital-equipment sector. During the spending boom, analysts say, there were too many players and too many miles of networks were built. That extra capacity could take several years to absorb.

"It could be a two-tiered recovery," said David Citron, a managing director in the Pikesville office of Carret and Co., a Manhattan-based money-management firm. "We think the rest of the economy could pick up in the next two months, while the rest of the economy - technology - will be well behind that."

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