Interest rate may go still lower
By George Hager
USA Today
WASHINGTON — The Federal Reserve is likely to cut its benchmark short-term interest rate target — already at a 39-year low — at least another half-point and perhaps as much as a full point to try to snap the nation out of its worst economic slump in a decade.
Fed watchers say policymakers will cut rates at least a quarter-point and maybe a half-point when they meet this week. Many analysts expect twin quarter-point cuts at the Nov. 6 and Dec. 11 Fed meetings.
But some economists say history dictates that the Fed will have to be even more aggressive to stop what most experts now agree is the nation's first full-blown recession since 1991.
"Historically, it's extremely rare a real recovery will begin when (inflation-adjusted) interest rates are positive, even by a small amount," said Mark Vitner, an economist for Wachovia Securities.
The Fed's short-term rate target is now 2.5 percent. Fed chairman Alan Greenspan's favorite measure of inflation — an obscure indicator based on consumer spending called the "core PCE deflator" — is now 1.6 percent. It would take a full one-point cut to make the inflation-adjusted Fed rate negative by pushing it down to 1.5 percent, a tick below that inflation gauge.
If history is any guide, said Vitner, that's what it will take to ignite a recovery. "In five of the last six recessions, it has been necessary for real interest rates to get into negative territory," he says. Only in the 1981-82 downturn did the real Fed funds rate fail to go negative.
"What has to happen is that the Fed has to lower rates to where just about any fool can make money by borrowing money," Vitner said.
The Fed has cut rates nine times since Jan. 3, pushing the short-term target from 6.5 percent to 2.5 percent. That has slashed rates to their lowest level since 1962. Even before Sept. 11, however, there was little sign that the deep cuts had done much to trigger a rebound.
In part that's because the traditional channels that convey the Fed's rate cuts to the broader economy aren't working as well as they have in the past, said Anthony Chan, chief economist for Banc One Investment Advisors.
The dollar usually falls almost 3 percent when the Fed cuts rates, making U.S. exports cheaper abroad and giving the factory sector a shot in the arm. But with Japan struggling and European growth a disappointment, traders have pushed the dollar up more than 6 percent since January, Chan said.
Long-term interest rates usually fall by more than 1.4 percentage points when the Fed cuts short-term rates, but the 10-year Treasury note has fallen only about 0.6 percentage points, Chan said.
Finally, the S&P 500 average usually rises by more than 14 percent after a round of Fed cuts, but since January it is down about 20 percent. "The bottom line is that the clear channels of monetary policy are not as supportive this time," Chan said.
On the other hand, economists agree that it always takes a long time for the Fed's traditionally slow-acting medicine to percolate through the economy.
"That's what people forget. They get way too impatient," said David Wyss, chief economist for Standard & Poor's. Usually, Wyss said, it takes rate cuts nine months to a year to have a major impact, which means the rate cutting that began last January would have begun to turn things around only now. Then came the terror attacks, which changed everything.
The Fed "doesn't have as much leverage as usual," he said. "A lot of it is Sept. 11, that people are just more scared of making a decision."
