PRIME RATE LOWERED September 29, 1998 The NewsHour with Jim Lehrer Transcript

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In response to growing economic problems at home and abroad, the Federal Reserve Board announced today that it will cut the prime interest rate by .25%. Jim Lehrer and guests discuss how the board's decision will affect the world's financial markets.

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A RealAudio version of this segment is available. NEWSHOUR LINKS: September 17, 1998: How is the global economic crisis affecting different U.S. regions? September 16, 1998: Secretary Rubin discusses the economic crisis. September 8, 1998: Will the Federal Reserve lower interest rates? August 31, 1998: The Dow Jones Industrial Average falls 512 points. August 26, 1998: Why is the Russian market collapsing? August 11, 1998: One World, One Market: Is globalization good or bad for America? July 24, 1998: Japan's ruling party chooses its next prime minister. April 3, 1998: The U.S. economy soars as Japan's continues to fall. February 3, 1998: The rippling effect the Asian economic crisis. Browse the NewsHour's coverage of economic issues and Asia. OUTSIDE LINKS The U.S. Federal Reserve Board . The U.S. Department of Treasury. New York Stock Exchange Nasdaq

JIM LEHRER: Reaction to today's interest rate cut from Laura Tyson, former economic adviser to President Clinton, now dean of the Haas School of Business at UC-Berkeley; Joel Prakken, chairman of Macroeconomic Advisers, an economic forecasting firm in St. Louis; Lyle Gramley, a former Federal Reserve governor, now consulting economist at the Mortgage Bankers Association of America; and Michelle Laughlin, economist and vice president for the Wall Street investment firm, Prudential Securities. Beginning with you, Laura Tyson, first, a quick go-around. Did the Fed do the right thing today?

LAURA TYSON: I think absolutely. It was a courageous move. It was the right move, and a very important signal to try to help and restore confidence in the global economy.

A move to restore confidence.

JIM LEHRER: Mr. Prakken.

JOEL PRAKKEN: It's hard to fault them for it. There's little probability that this will be a mistake, particularly since if events dictate, they can always take it back.

JIM LEHRER: Mr. Gramley.

LYLE GRAMLEY: I think they did, yes. I think it's hard to make a case that we really needed lower interest rates for the U.S. economy. But if the Fed hadn't moved today, we probably would have seen such a big drop in bond and stock market prices that we would have had adverse repercussions all over the globe. So I think they did the right thing.

JIM LEHRER: Ms. Laughlin, Wall Street wanted more, though, right?

MICHELLE LAUGHLIN: We wanted more. The Fed did the right thing by lowering rates. I think there's some debate about the magnitude of the move, but I certainly think going forward we'll see additional rate cuts. So we'll stick with what we got today and be happy with that for now.

JIM LEHRER: What exactly was – Wall Street wanted actually double that. They wanted a .50% cut, right, rather than just a .25%?

Is .25% enough?

MICHELLE LAUGHLIN: Exactly. And on top of that, we would have liked to have seen a cut in the discount rate. That would have been more of a symbolic move, but it really would have underscored the Fed's intentions and I think signaled to the markets that easier monetary policy was on the way. And I think that would have been very well received in the market.

JIM LEHRER: Laura Tyson, is it mostly a symbolic thing, or does it – will this actually have practical effects, both here and in the global markets?

LAURA TYSON: Well, I think it is a very important symbolic gesture. But it also has real effects. The symbolism is basically to say we recognize there's distress in the global market; we recognize it's beginning to show signs of erosion in the United States. We want to take a move now. It will bring down rates, particularly for consumers, and for investors, what the Fed is doing, it's sending a signal that they're concerned about the signs of a credit crunch, and that they are willing to send into the system the back-up needed really to keep credit flowing. That's the key signal today. It's a confidence signal.

JIM LEHRER: It's a confidence signal, Mr. Prakken, and you think that's really the basic move today, and that was the basic impact of it, a confidence move?

JOEL PRAKKEN: I do. A rate cut this small will have impacts on the other economy, but they will be quite modest. A larger point to be made, I think, though, is that Fed officials were trying to communicate to people out there that they're not asleep at the switch, and that if economic conditions dictated, they're willing to switch the emphasis of policy away from fight inflation to promoting economic growth.

JIM LEHRER: Do you agree with Mr. Gramley that by the time today came, the Fed really had very little choice?

JOEL PRAKKEN: I do. Financial markets had priced into them an expectation of a rate cut even somewhat larger than today and had the cut not be forthcoming, I expect that there would have been a backup in rates and a decline in the equity market; that would have been disturbing.

The trickle-down effect.

JIM LEHRER: Mr. Gramley, let's talk about some of the practical things. You work for the Mortgage Bankers Association. Is what happened today going to affect mortgage rates, credit card rates, consumer rates at all?

LYLE GRAMLEY: It won't affect mortgage rates very much because this move had been anticipated and bond rates have gone down, and mortgage rates right along with them. The benefits will come for consumers who have a home equity loan that's tied to the prime, because the prime, because the primary will probably go down. Auto loans that are tied to the prime --

JIM LEHRER: Would it go down about the same rate as --

LYLE GRAMLEY: Probably. A quarter of a percentage point on the prime. And that will bring down --

JIM LEHRER: And that's important. Tell us about what the prime is and why that's important.

LYLE GRAMLEY: The prime rate of interest is the rate of interest that banks charge their favorite commercial customers. But a lot of loans to consumers for buying autos or home equity loans are tied to the prime. So when the prime goes down, their loan payments will go down also.

JIM LEHRER: So there will be a ripple effect, right?

LYLE GRAMLEY: There will. There will, indeed. It's not large 25 basis points doesn't change the course of Western Civilization, but it does help.

JIM LEHRER: Does it cause people to – does it cause consumers to buy and do things they wouldn't otherwise do?

LYLE GRAMLEY: We might see somebody buy an automobile that they otherwise wouldn't have bought. Somebody whose home -- his equity payment loan has gone down—will have a little money – more money – spent over to spend for something else. But I think it's more the effect on confidence than it is on interest rates per se.

JIM LEHRER: Okay. Ms. Laughlin, what does this spur investors to do, both the Wall Street professionals and those who work with Wall Street professionals, in other words, their customers.

MICHELLE LAUGHLIN: Well, I think one of the things it's going to help to do, echoing what everybody else has said, is it shores up confidence. There's been so much volatility in the financial markets of late and the fact that the Federal Reserve had taken action really – you know -- confirming there's a doctor in the house I think will go a long way in reducing a lot of the volatility we've seen. It may encourage individuals, therefore, to stick with their stock holdings, not to liquidate. I think it will encourage investors to look at Treasury securities, which will benefit, particularly shorter-term Treasury securities, which will benefit as rates come down. And I think, in general, it will keep financial assets, you know, relatively well bid.

JIM LEHRER: Now, Laura Tyson, let's go beyond the United States now, because one of the underlying reasons given today by the Fed for doing this was the problems in the global markets. Give us a cause and effect now – 2.5 today helps people in Brazil, or helps people in Thailand or Russia or elsewhere in the world.

Banker to the world.

LAURA TYSON: Well, the cause and effect is, number one, to -- the U.S. has been one of the few sources of powerful economic growth in the world economy. And we are a very important market for countries that are trying to crawl out of very deep recessions, some of them even bordering on depression. So with stronger U.S. economy, stronger consumer demand in the United States, stronger investor demand in the United States means better market conditions for the rest of the world. That's number one. Number two is that investors around the world have gotten so spooked by problems, such as a default in Russia, and problems such as the issues in Indonesia and Malaysia, but they've been very unwilling to lend, even to very well-rated corporate borrowers and very good credit prospects around the world. What this does is – again, if it restores confidence and sends a powerful signal that credit conditions will ease, then I would hope that there would be some moneys that would become available for the good borrowers in the world who are not at this point able to compete for funds at all because investors have simply stampeded out of the rest of the world into safe U.S. Treasury bills.

JIM LEHRER: What do you say to those, Ms. Tyson, who would suggest that this now means that the Federal Reserve of the United States has become kind of the world banker, it changes interest rates and it affects everybody in the world?

LAURA TYSON: Well, I think that we are in a very unprecedented situation where we do have a very large global financial crisis going on around us. We do need institutions to play the lender of last resort role. The Federal Reserve, along with the other central banks of the G-7 nations, Europe, and Japan, can play that role. Japan really can't reduce interest rates much more. They've reduced them essentially to zero as it is. Japan could reform its banking system. The European Central Banks, I hope, will follow the Fed's lead and act as a group, collectively and cooperatively to provide some additional resources and some additional signs of concern to the global financial markets. Somebody has to play that role. And I applaud the Fed for taking the step today.

JIM LEHRER: Mr. Prakken, how do you see this thing beyond the United States and the effect it'll have on the global markets, and what – practical effects?

JOEL PRAKKEN: I think the newest concern for the Fed is a fear that the contagion that swamped Asia moved to Russia, could now overtake Latin America in our backyard, surrounding the United States and cut short the expansion. My view is that by itself the Fed cannot do all the heavy lifting. It can help around the edges, by making a little bit more liquidity available, by calming investors' concerns. But --

JIM LEHRER: By making liquidity available, that means by lowering the interest rates a little bit—that means that money is cheaper to borrow and there's more available, right?

"Money is cheaper."

JOEL PRAKKEN: Money is cheaper. The terms are easier. But I suspect, however, that bringing stability to South America probably will also entail help from the IMF, maybe in coordination with the United States Treasury, I wouldn't be surprised after the upcoming elections in Brazil later this week, that you see such an announcement. The Fed's move today I think should be thought of as part of a larger effort to stabilize that region of the world. And this is the little bit that the Fed can do to help.

JIM LEHRER: Now, Ms. Laughlin, of course, Wall Street is part of an international market, more so now than ever before, is it not?

MICHELLE LAUGHLIN: Absolutely. You know, one of the other assets – when you talk about some of the international consequences are benefits from the Fed action today -- there are a number of indirect effects probably worth mentioning, particularly when you look at the dollar, so many commodities are traded in dollars, and as the dollar has risen over the last year and commodity prices have dropped to 21 year lows, many economies have struggled, economies which are tied to oil, Canada, with 40 percent of their economy is tied to raw materials prices, and because their currency had weakened so much was forced to raise interest rates. They now will get some relief, and, in fact, the Bank of Canada was able to cut interest rates finally today. So I think there are a number of other indirect effects away from the confidence issue, which will provide some global relief.

JIM LEHRER: Mr. Gramley, how do you see the Fed now on this kind of new – this is new, is it not, to have this kind of power globally?

LYLE GRAMLEY: Well, the Federal Reserve has always had to take international considerations into account in formulating its policies. And I remember back in 1982 the Federal Reserve made a major change in the course of policy in part because of these – the serious state of the world economy. We were going through the Latin American debt crisis at that time. But I would stress that the Fed can't be the world's central banker. They couldn't have taken this step today if they thought that by doing so it would have adverse effects on the U.S. economy. They could go ahead and take this step because the risks of low inflation are quite minimal.

JIM LEHRER: But how should it be read, as a step to help the U.S. economy, or more to help the global economy?

LYLE GRAMLEY: I think it should be read as a step to tell the world that the Fed intends to keep the U.S. economy growing at a satisfactory pace, both for our own sake and to do whatever that can to facilitate a solution to this crisis internationally.

JIM LEHRER: But you had suggested earlier that you were really sure that the Fed really had to do this, they did it – I mean, they had to do it because of the advanced word and all of that, but as a practical sense and in a practical way you didn't think they had to do it. Why not?

Keeping a strong economy on track.

LYLE GRAMLEY: The current numbers coming in are still quite strong. Consumer spending is doing very well this summer. Most of our forecast numbers for the third quarter are being revised up. The housing market is doing very well. Initial claims for unemployment insurance are down below 300,000 a week. This economy still has a lot of momentum. We can see possibilities of a slowing pace of economic growth as time goes on, but we've been forecasting a slowdown since the middle of 1996. It hasn't happened yet. But this is a safe step to take. The Fed really hasn't taken any undue risk today.

JIM LEHRER: Laura Tyson, for the lay people listening, which is most of us, what will you professionals be looking at over the next few days and weeks to see if, in fact, the Fed action today had some kind of really good lasting, important effect here and elsewhere?

LAURA TYSON: Well, I think that we will be looking at what happens in global financial markets. One of the signs that we are in a very sort of fragile situation is the fact that even very well rated borrowers have had trouble floating new bond issues, is the fact that the risk premium, the additional amounts that countries or that companies have to pay above the Treasury bill rate to get money to finance worthwhile projects, that those premiums have gone up dramatically, and that discourages investment. So there will be a number of indicators that come from the financial markets, themselves, in terms of new bond issuance, initial public offerings, can companies actually issue new stock, what's happening to the premiums charged to borrowers around the world in different countries. Then, as we go on, we'll also see signs of what's happening to consumer behavior as consumer rates come down. I would disagree with the view that it was certain today that what the Fed should have done is reduce rates by .5%. I think the truth is that everyone should recognize we're in a highly uncertain situation right now. We've had a number of major surprises. Everything is very volatile. It seems to me very important for the Fed to send a signal, but at the same time to be extremely cautious. And, of course, to move .25% today – 25 basis points today – doesn't preclude moving further as more evidence comes in. I think the Fed is to be applauded for moving but also for being cautious.

JIM LEHRER: Mr. Prakken, what's your reading on whether or not – let's say this doesn't work. I mean, let's say things continue to get bad, not necessarily here but around the world, are there – is this -- this should not bee seen as an act of last resort by the Fed, there are other things to do ? Do you agree with Ms. Tyson, if this doesn't work, they can come back with another 2.5%, or do others – and it's still "a" solution to the overall problem?

Slower growth ahead?

JOEL PRAKKEN: The Fed cut rates today because the chances of slower growth or even a recession in the U.S. have gone up in his estimation. If, in fact, a recession does develop in the United States or becomes even more threatening, it will take a considerably larger decline in short-term interest rates to stem that than we've seen to date. But I think it's worth noting – and I do – I agree with Lyle in this regard – that one of the reasons the move today was so cautious is there are still signs out there that economic growth is faster than can be sustained indefinitely in the United States, and there are some indications that inflation fundamentals are gradually deteriorating. That means that the Fed has to be cautious in moving too quickly in a direction that could ultimately over-stimulate the U.S. economy.

JIM LEHRER: Okay. Thank you very much. I want to correct myself. I said 2.5% – what I meant was .25% – as all of you all knew – and I know the world knew as I said it a while ago. But thank you all four very much for being with us.

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