Down it Goes: Interest Rate Cut

JIM LEHRER:

Now today's interest rate decision by the Federal Reserve that so surprised and delighted Wall Street. The Fed explained its rate decrease action with these words: "…capital investment has continued to soften and the persistent erosion in current and expected profitability, in combination with rising uncertainty about the business outlook, seems poised to dampen capital spending going forward. This potential restraint, together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, threatens to keep the pace of economic activity unacceptably weak."

Here to translate and expand on that is: Mark Zandi, chief economist at Economy.com, an Internet site for economic and industry analysis; and Kathleen Camilli, director of economic research at Tucker Anthony, an investment firm.

Mark Zandi, how much of a surprise was the decision today?

MARK ZANDI:

It was a surprise, I think financial markets had all but given up on the Federal Reserve anticipating the next move wouldn't come until the they met in mid May, so markets were taken by surprise.

JIM LEHRER:

They thought that maybe there was no need or at least the Fed didn't think there was a need to act because the economy was doing a little bit better than before?

MARK ZANDI:

Well we all listened to the published speeches and pronouncements of Fed governors, and they had been giving speeches that were relatively upbeat. They were talking about an economy that they thought would turn around relatively quickly in the not-too-distant-future, so they didn't seem to be indicating at all the need for an inter-meeting cut.

JIM LEHRER:

Ms. Camilli, do you agree, were you shocked?

KATHLEEN CAMILLI:

I was a little bit surprised though I have to admit that in the last couple of weeks I have been telling some of the clients there was a possibility that the Fed could cut interest rates before the May 15th meeting, but nonetheless I was still surprised today and it makes me wonder what exactly what information they're looking at to determine today's action.

JIM LEHRER:

We'll get to that in a minute, but how unusual, Ms. Camilli, how unusual is it for the Fed to make a decision like this out of its normal sequence of regular meetings?

KATHLEEN CAMILLI:

Well I think that the various members of the Fed and chairman himself says repeatedly they always prefer to make policy decisions at regularly scheduled meetings and it's only when concern markets conditions changed adversely that they move to make a change inter-meeting.

JIM LEHRER:

All right Mr. Zandi, then how do you read the words — those wonderful words a read a moment ago — in terms of what is the Fed saying is it s going on in the economy now that prompted this unexpected decision?

MARK ZANDI:

Well, that is a mouthful but really what I think is going on is that we've seen a number of very poor corporate earnings announcements over the past few days… two large information technologies companies, CISCO and Intel have come out with their earnings and they're very dark. We're seeing an implosion in demand for information technology products; investment in these products is just plunging. And I think that was the approximate reason or the catalyst for the Fed's decision. They're very worried that the sector of the economy information technology that was the engine of growth for at economy since the mid 1990s is not only going from very strong growth to no growth but actual outright decline. So this is a major problem that seems to be intensifying very rapidly.

JIM LEHRER:

Because of what Chairman Greenspan has said about the new economy and how it was driving productivity — technology was driving productivity, you're thinking that maybe they suddenly saw this one not doing as well as they had expected?

MARK ZANDI:

Yeah, really two things. First there is a near-term problem. Businesses were spending a lot of money on investment and this was driving a lot of growth. These companies were hiring lots of people and they were spending lots of money that was driving the economy's fantastic growth in recent years. That's disappearing very rapidly. But you're right, even more importantly longer run this investment boom we were in was lifting underlying productivity growth and was going to at least it was thought it was going to lift our living standards at a faster rate for a long time to come. That clearly is in jeopardy here with the investment falling off rapidly as it is.

JIM LEHRER:

Ms. Camilli, how do you read the words that accompanied this decision today from the Fed?

KATHLEEN CAMILLI:

Pretty much the way Mr. Zandi has described. I think that, you know, the rule of enthusiastic we used to use in economics 20 years ago for every one manufacturing job that was created there were four or five other jobs — ancillary jobs created — it is the multiplier effect. And I think that the same thing is going on in technology today. So, the rapid loss of jobs in that sector of economy threatens to have a spillover effect — dragging the entire economy down into recession — and I think that the Fed is trying to ameliorate what's going on to the best it can. The important thing to remember however is that after every investment boom in history like the one we just experienced there is typically an investment bust. Unfortunately the economy needs to go through the process of the bust. The good news is that after we get through this what I would call a cyclical adjustment process — I believe that the Fed chairman has even used that terminology himself — we will get to a plateau in the economy from which a new economic expansion will start. And I expect that will be sometime in 2002.

JIM LEHRER:

Is there a simple explanation as to why a bust always has to happen?

KATHLEEN CAMILLI:

Well that's an excellent question. I think it's because capital moves rapidly to the businesses that are being started up where the new ideas are forming. And typically there is a euphoria associated with that. And the levels of share prices can go too high. And the capital moves away and there is a bust. So we've seen it happen before many, many times in history.

JIM LEHRER:

Mark Zandi, explain from us non-experts now how today's action is going to help things.

MARK ZANDI:

Well a number of ways. Most importantly and most immediately hopefully it lifts everyone's spirits. The difference between a weak economy and a recessionary one is confidence and if we lose confidence as investors, as lenders, as consumers and business people, then we will have a recession. I think that the message in the Fed's actions today is that they're very serious about forestalling the possibility of a recession. They're going to do everything in their power to ensure that the expansion continues on. And their hope is that that shores up confidence and makes us a little bit more willing and able to go out and spend and invest and do the things necessary to keep the economy rolling.

JIM LEHRER:

So it's a psychological thing?

MARK ZANDI:

That's the most important immediate thing. Fundamentally, though, lower rates help. Any of us who have credit cards or home equity lines or adjustable rate mortgages will benefit when rates come down and also many hard pressed businesses that are trying to finance these inventories and companies that have commercial paper outstanding and other debt that's tied to market interest rates — they will benefit almost immediately because they're debt burdens will begin to come down.

JIM LEHRER:

But, Ms. Camilli, here again for us non-experts — explain why — all right — the Fed decreases or lowers the interest rate but at the same time the words are very gloomy. Wall Street reacts in a kind of state of the euphoria as this is good news and so why is it good news?

KATHLEEN CAMILLI:

Well, they perceive that the can see a light at the end of the tunnel. In other words, what Wall Street has been focused on of late is that the bad earnings reports coming out of companies, and so if liquidity is provided into the financial system, into the economy the hope is that the company's fundamentals will turn around shortly and that the injection of liquidity will help the fundamentals turn around and we'll see a light at the end of the tunnel. I think that unfortunately it's going to take some time. And if you look at some earnings projections of the technology companies you're looking far out into somewhere around the end of the year, the 3rd or the 4th quarter. So we need to get through that but in the meantime lower interest rates, as Mr. Zandi said, will help the consumer sector of the economy and some business too.

JIM LEHRER:

So do you agree with him, though, that the major impact is more psychological than it is real?

KATHLEEN CAMILLI:

I think it's both actually. I think for consumers who have adjustable rate mortgages they can go out immediately and refinance them perhaps; gives them a chance to kind of clean up their household balance sheet they maybe over leveraged. So, you know, you're buoying the consumer side of the economy lowering interest rates while this other sector of the economy is going through a contractionary process.

JIM LEHRER:

Mr. Zandi, a lot of people speculate lot about the question of whether or not the Fed is reacting to much to the stock market and/or too much to statistics or whatever. How you would read this? Is this a stock market driven decision today or is it driven more by consumer confidence problems, corporate earnings, how would you evaluate it overall?

MARK ZANDI:

No, this is not driven by the market. In fact, the market had improved over the past several days. In fact, to some degree they probably did it today because they couldn't be accused of pandering to the market.

JIM LEHRER:

Because the market had gone up earlier when it first opened even before the Fed decision, right?

MARK ZANDI:

That's right. I mean, it actually reacted fairly positively to the very bleak news from CISCO and Intel and other IT companies. You can't accuse the Fed of doing that because the Fed is clearly reacting to an economy that is still eroding. I mean, I think to some degree policy makers misjudged what was going on. They thought that if they could get through the problems among traditional manufacturers, among vehicle producers and building materials companies and chemicals, textiles, apparel, that if we could work through the problems there, we would be home free, but that clearly is not true. It's growing — the evidence is growing that the IT sector is struggling.

JIM LEHRER:

IT —

MARK ZANDI:

Information technology — which is a big chunk of our economy and a huge chunk of our growth at least in recent years. And it's struggling so significantly and as has been pointed out it will continue to struggle for some time. I think that's what they're reacting to they realize now they probably misjudged what was going on.

JIM LEHRER:

But why today, Ms. Camilli? Why today? I mean, the stock market was doing well when it opened to morning based on good earnings report from AOL/Time Warner, right — and other things were happening and the market was on its way up, and then the Fed came along and shot it up even higher.

KATHLEEN CAMILLI:

Yes. I have no real explanation for why today over another day. What I can say, though, is that, interestingly enough, the bond market in the last several weeks the yields had been moving up almost anticipating an economic recovery and I think there was kind of a dichotomy that was developing between what the bond market was interpreting as going on in the manufacturing sector of the economy and consumer sector — anticipating a recovery — and what was really going on is the technology sector. And I think —

JIM LEHRER:

Which is getting worse, you mean?

KATHLEEN CAMILLI:

Which is getting worse, and so today's action to me highlights the fact that most of our government data that we watch on a daily basis really tell us very, very little about the new economy; we have a tremendous data insufficiency in the area of measuring the new economy, so hopefully going forward we're going to use some of those surplus dollars to get some good hard data, because I think that's what probably the live information from the companies probably is what prompted the decision today.

JIM LEHRER:

Okay. Mrs. Kathleen Camilli, Mr. Zandi, thank you both very much.