NYTimes.com Article: Impatient Fed Seems Ready to Cut Again

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Commonsense Semiology: The threats of deflation?  How does one interpret these 
data other than in the context of the boom and the bubble economy?  

tganesh@stlawu.edu

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Impatient Fed Seems Ready to Cut Again

June 24, 2003
By DAVID LEONHARDT 




 

For most of the last two years, if not the last decade,
Alan Greenspan has given the American economy the benefit
of the doubt. 

The hangover from the 1990's boom has helped create the
longest hiring slump in more than 60 years, yet Mr.
Greenspan has used almost every public appearance to
describe the economy as fundamentally sound. While some
other Federal Reserve officials have argued in their
closed-door meetings for a more aggressive campaign of
interest rate cuts, Mr. Greenspan, the Fed's chairman, has
counseled caution. 

His patience - and that of almost every other top Fed
official - now appears to have run out. 

The Federal Reserve seems ready to cut interest rates once
again when it concludes a two-day meeting that begins
today. Economists and investors are divided over whether
the cut will be one-half of a percentage point or a
quarter-point, but they are nearly unanimous in thinking
that the Fed will reduce borrowing costs to encourage
business and consumer spending. 

A rate cut would come despite a 20 percent jump in the
stock market since mid-March and early signs that retail
sales are rising, manufacturing is recovering and inflation
is picking up slightly. Even a quarter-point reduction
would lower rates to their lowest level since the 1950's. 

"The Fed is saying, `Until we see the whites of the eyes of
a strong economy, we're going to continue to ease,' " said
Robert J. Barbera, chief economist of ITG/Hoenig, an
investment firm. "They don't want ephemeral signs. They
want the original article." 

As recently as September, the Fed brushed aside requests by
two members for a rate cut. Early this year, Mr. Greenspan
sounded another confident note by suggesting that the
economy would revive once the main fighting in Iraq, and
the uncertainty it created, was over. 

But after two years of unfulfilled hints of a true
recovery, the late 90's bubble in stock prices and
technology spending now appears to have had more lasting
effects than many policy makers expected. 

"We've gotten a lot of these imbalances out" of the
economy, but the process is "not finished," a Fed official
who insisted on anonymity said. 

Officials now say that the risks of not acting appear to
outweigh the risks of setting off inflation by flooding the
economy with money. They have specifically spoken of the
potential - which they call unlikely but dangerous - for
deflation, a sustained decline in prices that can cripple
an economy by causing wages to fall and debts to become
unmanageable. 

"There's still a pattern of weakness and sluggishness that
argues that policy makers ought to be very, very vigilant,"
said R. Glenn Hubbard, a former top economic adviser to
President Bush who is now an economics professor at
Columbia University. "That weakness could actually spiral."


However encouraging the most recent data, almost no one
considers the economy healthy. 

Wal-Mart managers have recently seen some customers
carrying calculators through their stores, apparently
adding up their bills before they go to the register, a
company spokeswoman, Mona Williams, said. More merchandise
is being scattered around the stores, suggesting that
people are changing their minds about what they can afford
in the middle of a shopping trip. And packs containing more
than one shirt have not been selling well. 

"The country at large might be more optimistic about the
economy," Ms. Williams said, "but the people we see in our
stores are still very cautious about how they spend their
money." 

Still, the economy does seem as if it may be near a turning
point, regardless of whether the Fed again cuts its
benchmark rate. The rate - which directly affects the cost
of automobile, credit card and many other loans - is now
1.25 percent, after 12 reductions since the beginning of
2001. 

The rise in prices on items other than food and energy -
known as core inflation - reached an annual rate of 3.2
percent last month, more than in any other month since last
August, according to the Bureau of Labor Statistics.
Manufacturing activity has increased to the highest level
in months, two Fed surveys reported last week. The number
of people filing new claims for jobless benefits has fallen
for two weeks. 

These whiffs of a recovery helped send the Standard &
Poor's 500-stock index briefly above 1,000 last week for
the first time since the summer of 2002. The rally swelled
consumer savings and made it easier for businesses to
finance projects by issuing new shares. 

Just as important, Fed officials' recent statements of
concern over deflation have convinced bond investors that
the Fed will keep short-term interest rates low for some
time. Long-term rates, which are set by the market, have
fallen further as a result, making mortgages and other
loans less expensive. 

Speaking to a bankers' conference early this month, Mr.
Greenspan said that the changes in the credit markets
suggested "a fairly marked turnaround" for the economy. 

The markets have not offered so much reason for hope at any
point in the last three years. But other suggestions of a
broad economic recovery have emerged at various times, only
to prove fleeting - and to undermine predictions by Mr.
Greenspan and his colleagues of turnarounds in 2001 and
again in 2002. Either a new shock has occurred - like the
wars in Afghanistan and Iraq, or the corporate governance
scandals - or the brief spurts of optimism have wilted
under the bubble's weight. 

The stop-and-start growth seems to have chastened the Fed a
bit, economists say, leaving policy makers to consider
whether the economy is perhaps facing less positive
prospects. The scariest comparison involves Japan, which is
suffering from deflation after a bubble of its own helped
create a decade of weak growth. 

"The striking thing about Japan is that in the post-bubble
environment, growth consistently disappointed forecasters,"
said Dean Maki, a vice president at J. P. Morgan Chase and
a former Fed staff member. He added that in its study of
Japan, the Fed "concluded that the Bank of Japan had the
right policy for the forecasts" but did not cut interest
rates quickly enough to halt the economy's decline. 

Because deflation appears harder to reverse than it is to
prevent, Fed officials seem willing to take out insurance -
a word Mr. Greenspan has used - against it, even if they
regard it as unlikely. Recently, they have also become
concerned about the effectiveness of measures they might
take if they still needed to stimulate the economy after
their benchmark interest rate reached zero - for instance,
buying long-term bonds. 

Roger W. Ferguson Jr., the Fed's vice chairman, said in a
recent speech that the measures "are not simple to execute
or without downside risks." 

The only uncertainty, analysts say, is how aggressively the
Fed acts this week to ensure that the economy recovers.
Investors rate the chances of a half-point cut and a
quarter-point cut as roughly even, according to the price
of a futures contract based on the Fed's actions. And of
the 16 Fed experts polled on Friday by Macroeconomic
Advisers, a forecasting firm, 10 predicted a quarter-point
cut and 6 a half-point reduction. 

But nearly all economists agree that the Fed is bound to
release a statement tomorrow that tries to keep long-term
rates low by suggesting that officials have no plans to
raise the benchmark rate anytime soon. An increase will
come only when the long slump is clearly over. 

http://www.nytimes.com/2003/06/24/business/24ECON.html?ex=1057493427&ei=1&en=7bc97f0c62837f7f


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