TOPICS > Economy

Federal Reserve Rate Cut

June 25, 2003 at 12:00 AM EDT


GWEN IFILL: Today’s decision by the Federal Reserve to cut interest rates by a quarter point is the 13th rate cut since early 2001. As a result, rates are now at their lowest levels since 1958. In a statement explaining its decision, the Fed’s Open-Market Committee said some recent economic signs were encouraging “a firming in spending, and labor and product markets that are stabilizing.” But the committee also concluded that the economy still shows little sign of what it called “sustainable growth.”

For more on today’s action, I’m joined by: David Jones, a Wall Street analyst and president of D.M.J. Advisors; Diane Swonk, chief economist at Banc One; and Ellen Frank, a professor of economics at Emanuel College in Boston. So David Jones, what do you make of the quarter point rate cut?

DAVID JONES: Well, I would call it an insurance policy. As you noted, we have come down 13 times since the beginning of 2001 on that short term Federal Funds rate from 6.5 percent to 1 percent. I think the Fed is hoping that they can keep interest rates low enough, long enough to finally get the economy back on track and just see enough growth to create jobs. That’s really the story here.

GWEN IFILL: Diane Swonk, if you agree that this is an insurance policy, what are we insuring against?

DIANE SWONK: Well, what we’re insuring against is weaker growth later on in the cycle. The Fed Reserve — I think David made a very good point, is that the Federal Reserve is trying to hold down rates for a long period of time. What they don’t want to happen is say more sustainable recovery to start getting going and all of a sudden rates to rise and cut off some of that recovery. They would really like to hold down rates for an extended period of time.

I think it’s also important that the Fed note was a little more upbeat in their view of the economy, although they sort of said they can smell a recovery up there; they can smell a rebound out there but we can’t taste it yet. Until we can taste it, get dinner on the table; no one is going to be satisfied. I think that’s why the Federal Reserve is sort of hedging its down side, worrying about what might the economy later on that we don’t know about yet. We have seen a lot of surprises out there over the last couple of years, and the Fed just doesn’t want to deal with any surprises going forward.

GWEN IFILL: Ellen Frank, do you smell a recovery coming along here and does today’s action do anything to help that along?

ELLEN FRANK: Well, the economic signals right are very mixed. We’re seeing some signals of increased growth but nothing really strong. What is really worrying the Fed right now is that the Consumer Price Index for the past two months declined in April by three tenths of a percent and it was flat in May. And this raises the potential where the United States economy could suffer deflation where prices fall. In which case the Fed has to keep interest rates very, very low and may actually have to drag them to zero to have any benefit to the economy at all.

GWEN IFILL: David Jones, I have had people say to me and you probably have had people say to you when these cut the rates are imminent, oh, good, I hope they cut the rates so I can get a better mortgage. Does this really affect people’s mortgages or their credit card statements?

DAVID JONES: Actually, what is interesting is the mortgage rates have been already been affected. Think back to the Fed’s last meeting on May 6. They made the announcement that deflation was a greater threat than inflation. People in the bond market were surprised; they said, hey, the Fed is going to keep rates low for a long period of time, and so we saw a huge decline — more than half a percentage point in long-term interest rates and suddenly we saw mortgage rates down around 5 percent or slightly below Treasury yield. The ten-year Treasury yield came down sharply in some sense we have already seen the good news on the long-term interest rate side. I think what the Fed wants to do now is simply keep both short-term rates and long-term rates low long enough to get growth back on track. It’s a very uncertain period. There’s no question about it. But I really don’t see an imminent threat of deflation, or, if we get it, it will be the kind of deflation that comes with high productivity growth that we saw back in the 1950s was not too harmful to the economy.

GWEN IFILL: Give us the Economics 101 explanation of deflation.

DAVID JONES: A decline in prices. Economists are constantly trying to confuse people; being one I know that. Disinflation is a slowing of the rate of growth in inflation or the rate of growth in prices, just a slowing in consumer prices or other price measures. Deflation is when prices across the board actually fall. We’re in a far distance from that right now. Actually we have essentially price stability where the various price measures are running year over year at 1.5 percent. So we’re a long way from an overall decline in prices.

GWEN IFILL: Diane Swonk do you think that Fed is correct to be worrying about deflation?

DIANE SWONK: I think deflation is not really on the top of the Fed’s list. I think they are using that as a bit of a boogie man for the bond market out there to try to keep long-term rates low. They’ve admitted themselves it’s a minor risk. But it’s kind of like you take your child — I’ve recently gone through this — I took my child into the emergency room recently because he had an asthma attack; and he did not have a severe one but they gave him all the steroids anyway to make sure that death was not a possibility.

Well, deflation is economic death, so even though it was even more minor than it was when I took my son into the hospital, we’re giving the economy all the steroids we possibly can to build a stronger, more robust recovery down the road and get to an expansion, although we know that steroids have consequences when used over time. We have really got this trifecta of economic stimuli out there. We have got tax cuts; we’ve got lower interests and we’ve got currency weakness. We have never had such a powerful combination of economic stimulus together, all coming together at the same time.

So if the payoff isn’t there, frankly, I don’t know what will stimulate this economy. I think we will see a lot of rebound from this and then frankly at the end of day we’ll be talking a year from now about over stimulating the economy, but of course hindsight. is always 20/20 and like I said before, until the meal is on the table the Federal Reserve is not going to feel comfortable about where we are in this economic recovery.

GWEN IFILL: Ellen Frank, let’s say with the steroids analogy for a moment. First of all, I’m curious about whether you agree with that and, secondly, if it is true that they are throwing everything, the kitchen sink, into this economy to get it going again, are they overdoing it?

ELLEN FRANK: Well, I think the Fed is trying everything. I’m not sure I would say that about the federal government. I think the fiscal policy, although on paper it is very stimulative, we have about three or four hundred billion dollars in protected deficits, most of that stimulus is being sent to people who are not going to spend a lot of money they are receiving. It’s not the same as if the federal government were creating job programs or giving money to the states to plug the holes in their deficits. So we’re not having… the fiscal stimulus is not great. Although it is true that currency — value of the U.S. dollar has been declining in recent months, it’s also true that the latest reports showed that our trade deficit has increased, which is a bad economic sign because other countries are in very deep recession themselves.

Many of the countries in South America are in trouble, the European economies are in trouble. Germany is in trouble. Japan is in trouble. And we exist in a world economy. If the world economy isn’t growing and we don’t have some kind of investment boom really pushing things in this country, then there is a very grave threat of sustained stagnation.

I think this is what the Fed is worried about — not so much that we’ll go into a recession, another recession, but that the economy simply won’t grow again, won’t grow again enough to create the jobs and increases in income that for most people mean a good economy; and if the economy doesn’t grow again and we have these weaknesses surrounding us, then there is I think a very severe possibility, a very serious possibility that prices could start to decline and in that case, then the deflation would exacerbate the bad conditions in the economy by making it very difficult for people to repay their debts.

GWEN IFILL: David Jones, we saw the stock market tumble by about almost 100 points today after the Fed made its move at around 2:00 this afternoon. Is there anything to be read into that?

DAVID JONES: I would look at that as what we used to call a knee jerk reaction. There were many investors who were hoping that the Fed would cut rates even more, a half a percentage point rather than a quarter percentage point. But I think if we put everything together here, the large number of interest rate cults all together, the low long term interest rates, and those three rounds of tax cuts, I think we do have enough fuel to get this economy going again. And the stock market while it may have reacted negatively initially has come up a long way in anticipation of a better economy in the second half of the year.

GWEN IFILL: And to stimulate the kind of investment that Ellen Frank was just talking about.

DAVID JONES: That’s right. The key there is a combination of accelerated depreciation for businesses in the tax cuts and a higher return on investment that comes from cost savings due to higher productivity growth. Businesses have a better environment now and I think by the end of the year we’ll finally start seeing businesses buying new equipment which they put off for number of years.

GWEN IFILL: Diane, Paul Solman on this broadcast told our viewers last week about the jobless economy — the jobless recovery, the jobless economy however you want to put it, does an action like today by the Fed do anything to stimulate that to stimulate people for long term investments that jobs are created?

DIANE SWONK: Much of movement, as David mentioned, was already made in the market. So we already saw a lot of that movement. The corporate sector has actually been restructuring their debt, much like consumers have, which is freeing up cash to actually spend, and that’s what we want them to do to finally create some jobs out there. I think it’s important to point out like the reminiscence of this like the early 1990s high productivity growth but not a lot of payroll growth. People are sort of talking about that, saying isn’t it horrible. Well, first of all, in the early 1990s we were two percentage points higher on the unemployment rate than we are today and secondly, boy, didn’t that decade turn out to be tremendous in terms of raising living standards and finally getting to the people who are lowest on the income rungs with extremely unemployment rates by the end of it.

So if I had to choose a recovery where you bounced out of it but didn’t get very far because you got all of your growth up front or a little more painful recovery but more sustained expansion, I would choose the latter. And that’s what we’re set up for now. There are similarities with the 1990s and frankly, I’ll take them because I think that sets us up for what will turn out to be much better job growth down the road and lower unemployment and some increase in living standards down the road from that productivity that is very important.

GWEN IFILL: Ellen Frank, we’re now at 1 percent. How low can they go and should the Fed go any lower?

ELLEN FRANK: Well, they can go only as low as 0. After that they have used up all their ammunition. Should they go lower I think remains to be seen. I mean, the Fed has to walk a very precious line because here because if they over-stimulate the economy, if they put too much money into the banking system, make money too cheap, they could set off another asset boom and bubble like we had before, and although that’s good in some ways because it leads to a lot of growth and increases in employment, it’s not sustainable; it doesn’t last over the long haul. So they have to be careful not to overdo things.

On the other hand I think their sentiment right now is that the down side risks outweigh the upside risks. That they need to be cautious and they need to be concerned about what happened in Japan of the bubble burst there in 1990s where the central bank sat idly by and did nothing and allowed economy to slowly collapse and prices to start to decline. By the time it acted it was too late. I don’t think the Fed wants it be in that position. We all hope that this works and that we start to see increases in jobs.

GWEN IFILL: Let me ask you each briefly, what does your expertise tell you about whether this indeed will work, this sort of action. David Jones?

DAVID JONES: I think it will. It’s a closer call than I think Chairman Greenspan or his fellow policy makers were anticipating. They had to push rates lower and they’ll have to keep them there longer. But when combined with three rounds of tax cuts in the Bush administration and a declining dollar, I think we’re generally looking at a situation where we have least a chance of gradually accelerating growth in the second half of the year.

GWEN IFILL: Diane Swonk?

DIANE SWONK: Like I said all the ingredients there are for the recipe for a boom going forward. Not right away and ladle on top of 2004 that it’s an election year. You can bet their spending more government money out there. Whether it’s for good, better or worse it stimulate the economy in its own way.

And I think what we have to look at it is we have never had this kind of line up of stimulus in the economy both public and private sector — private sector equity market rally. Lower oil prices on the horizon. Lots of good stuff coming our way and we literally could blow the top off by 2004. But as the Fed sits there, they can smell it. They know we’re cooking it in the kitchen but until we serve it up on the table they’re not going to be happy.

GWEN IFILL: Ellen Frank?

ELLEN FRANK: I think it’s hard to say. I hope, like everybody else, it works and the economy starts to grow again. I hope we start to see income growth and job growth very soon. I think we would have a better shot at that if we made more of an attempt to coordinate policy with Europeans and other governments because we live in a global economy now and we have to consider the global implications of the world we live in, but I’m hopeful.

GWEN IFILL: All right. Thank you all three very much.