February 2, 2001
There's Nothing Subtle About Fed Policy These Days
The legendary jazz composer Duke Ellington once said that the proper way for audiences to respond to the music was to slightly tilt one's head, on the off-beat to the rhythm. That same sophisticated reserve, not in notes but in economic policy, has raised the stature and the aura of the Federal Reserve over the last nine years, as the U.S. economic expansion lived on and on. It has even produced a glowing autobiography of Fed Chairman Alan Greenspan, appropriately titled "Maestro."
But by the act of lowering short term interest rates by a full percentage point within the space of a month, the Fed has retired the conductor's baton in favor of a cattle prod. Thoughts of fine-tuning the economy with words and subtle tweaking of policy have evaporated in the wake of an unexpectedly swift and severe drop in consumers' and business peoples' confidence in the short-term future. With the very life of the expansion at stake, Mr. Greenspan has taken off the white gloves and is letting us see him sweat.
The irony in the Fed's dramatic action is that its immediate impact can only be on our minds, not on the economy itself. For unlike a real maestro, when the Fed raises its baton through the act of lowering interest rates, it can take six months or more for the orchestra of economic actors to meaningfully respond. Interest rate declines will incrementally affect short term capital budget decisions, which will take time to bring about changes in orders and purchases that ultimately add up to changes in economic activity.
By that time, the question of whether or not the U.S. economy is in a recession will be largely settled. And recently released reports on growth in the fourth quarter of year 2000 make it clear that we are skating closer to the edge than we have been in a long time.
A contraction in business spending and a surprising turnabout in export sales led to a lower than expected 1.4 percent rate of overall growth in the U.S. economy in the last three months of 2000, according to the Bureau of Economic Analysis' report on Gross Domestic Product. Reasonably strong growth in consumer spending on services, on the other hand, led to a 2.9 percent rise in consumer spending overall in the year's final three months, helping keep the economy afloat.
Of all the trouble spots in the BEA's report on fourth quarter growth, the downturn in business spending is perhaps the most worrisome, especially for the longer term. Not only were the double-digit increases in spending on capital and equipment earlier last year a sign of business confidence in the future, but they led to productivity increases in the economy that made rapid growth without damaging inflation possible.
There is every reason to believe that the economy is nosing down even further as these words are written. Although a modest recovery in business and consumer spending is likely, given the stable inflation environment and the reasonable job security most of us still enjoy, the bulge in inventories brought about by overproduction at the end of the year promises to keep production schedules at lower levels for a while.
That prognostication, of course, assumes that no other surprises occur between now and the summer. With the economic growth already coming within view of the ground at the end of last year, there's clearly not much room for error if a recession is to be avoided.
Did the Fed wait too long to lower interest rates? If the answer is yes, it wouldn't be the first time that our economic policymakers proved to be as mortal as the rest of us.
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