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The Honolulu Advertiser
Posted on: Wednesday, November 6, 2002

Possible Fed cut may not help economy

By Peter G. Gosselin
Los Angeles Times

WASHINGTON — As political Washington spends today picking at the bones of a congressional election whose main message is that not much will change, economic Washington is poised to do something very similar.

If surveys of prominent forecasters are correct, the Federal Reserve will cut its benchmark federal funds rate from its current 41-year low of 1.75 percent to 1.5 percent, or perhaps 1.25 percent. The action will almost certainly be hailed as just what the staggering U.S. economy needs.

The only problem: The new cuts are unlikely to do much good, and could do some harm.

That's partly because the Fed already has cut rates considerably, and low interest has worked much of the magic it can.

In the past few years, rate-driven consumers have replaced one-third of all the country's cars and financed or refinanced almost all of its houses. Banks are unlikely to offer 30-year mortgages much below 5.75 percent. Automakers are going to be hard-pressed to beat the zero percent financing they already offer.

Some worry the boost is distorting the economy. Two-thirds of last quarter's growth was because of auto sales.

And that still hasn't been enough, largely because the central bank has been unsuccessful with the other actor in the nation's economic drama: business. And therein lies a clue to why its new rate cuts are unlikely to make much difference.

The way the system is supposed to work is that when the Fed raises rates, lending falls; when it cuts rates, lending climbs. But in the past few years, the opposite has happened.

"The Fed hasn't been able to convince businesses to borrow from banks, or anybody else for that matter," said Mark Zandi of Economy.com, a forecasting company in West Chester, Pa.

Some who advocate a new round of Fed rate cuts argue that the central bank simply did not cut far enough and fast enough to get the results it wanted and must now finish the job. They may have a point.

Because, after getting a roaring start by slashing the funds rate 11 times in 2001, Fed policy-makers have not budged for almost a year. One way to gauge the dimensions of their pause is to compare it to the Bank of Japan's performance in the early 1990s.

The BoJ has become the poster child for bad central banking because it raised rates just as Japan's stock market and economy were coming apart and was slow to reverse course and begin cutting.

Americans have taken no end of comfort from the notion that their Fed acted very differently.

But if one dates the start of the Japanese bust to the collapse of the Nikkei stock average in 1990 and the start of the U.S. bust to the free-fall of the NASDAQ index in 2000, then the performance of the two central banks begins to look much more alike. Roughly three years into their respective troubles, U.S. and Japanese policy-makers had each shaved between 4.5 and 4.75 percentage points from their benchmark interest rates. The only difference was that Fed officials acted faster, then stopped.