Thu, May 17, 2001 page19

• Capital spending push seen to be behind reduction

  Greenspan's strategy contains some risks, analysts caution, as the cuts still may not be enough to spur the US economy into a recovery very quickly. The nation's GDP growth could well remain sluggish for several months

  • By Art Pine / BLOOMBERG
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  In cutting the benchmark overnight lending rate by half a percentage point on Tuesday, the Federal Reserve dismissed speculation that it might be ready to pause for a few months in its drive to spur the economy.

  It also brushed aside warnings by critics that inflation pressures may be accelerating, noting that labor market pressures were easing and predicting that productivity growth would bounce back. That last one may get it into trouble.

  "They're pretty much committed to easing until the economy starts to show growth again," said Paul Kasriel, economist for the Northern Trust Corp in Chicago. "There's no indication that they're contemplating a pause."

  Instead, the action on Tuesday by Fed Chairman Alan Greenspan and his central bank colleagues seemed aimed at one objective: to spur capital spending, which it pinpointed as the biggest threat facing the economy.

  Inflation

  "It's clear that inflation is something that either Greenspan or his successor will have to deal with later," said Kasriel, who says the Fed is erring by not worrying more about labor costs. "It's not an issue for him." The central bank's action marks the fifth such move in a stunning economic rescue operation that only 4 1/2 months ago it wasn't even contemplating.

  "The danger signs were accumulating last fall, and the speed of the slowdown in manufacturing took the Fed by surprise," said Roger Kubarych, a former Fed strategist now with the Council on Foreign Relations. "It was totally unforeseen." Since then, Greenspan has been moving aggressively to cut interest rates and avoid the mistakes he made at the start of the 1990-91 recession, when he waited too long to act.

  With Tuesday's rate cut, the Fed has reduced the overnight lending rate by 2 1/2 percentage points, to 4 percent. Many analysts say it will approve one or two more before it finally takes a rest.

  Overall, it's the steepest rate cut Greenspan has engineered in his 12-year tenure as chairman. The Fed cut rates by 2 1/2 percentage points in 1982, but it started from a higher level.

  Greenspan's cut is proportionally larger.

  "It's a perfect example of what Greenspan meant when he said the Fed must move more rapidly now to deal with economic problems," said David Jones, a Fed-watcher at Aubrey Lanston & Co in New York.

  Even so, the strategy contains some risks, some analysts caution.

  The cuts still may not be enough to spur the economy into a recovery very quickly. The growth rate may remain sluggish for several months.

  "It looks as if they're trying to revive a dead horse," Kasriel said.

  Worse yet, the Fed may have underestimated the inflation threat, Kubarych says. "You could get something like a wage-price spiral out of this," he said. "That would be the downside to this whole strategy." Also unanswered is how much the Fed's decision to continue easing might heighten any conflict between monetary policy and fiscal policy, especially the 10-year, US$1.3 trillion tax cut that the US Congress is expected to pass in July.

  Risk

  "The biggest risk is that they might get whipsawed, with the economy taking off just as the big tax cut goes into effect," said David Wyss, chief economist for Standard & Poor's, the financial rating company.

  "That would force them to change course quickly, possibly pushing the economy into a recession in 2004," Wyss said. "The same thing happened after the stock market crash of 1987, and it must be on their minds." For the moment, the Fed seems confident in what it is doing and determined to see the economy through to a recovery. When the slowdown began, some analysts complained the Fed was behind the curve in dealing with the slowdown. They're not saying it now.

  Nevertheless, the central bank has raised new questions over its willingness to brush the inflation issue aside, even in the face of sharp increases in labor costs and energy prices.

  "People thought they needed to address inflation," said David Orr, chief economist at First Union Corp in Charlotte.

  "They addressed it by saying there is no problem, which I find fascinating." Or possibly worrisome, a few months down the road.
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