January 5, 2001
What's Behind the Fed's Bold Move
If you're at sea in a storm, you can't expect the captain of your boat to give you an honest answer about the ship's condition. It's usually better for the passengers to be calm than to be well informed. But no matter what he or she tells you, if you hear the order go out for the lifeboats, you know you're in trouble.
That was the essential message delivered by the Federal Reserve's surprising decision to lower interest rates under its control by as much as a half percentage point last week. The size and the timing of the Fed's move speaks more loudly than any words can. The message is clear: the U.S. economy is in greater danger of sinking into recession than policymakers have been letting on.
It is ironic that this bold policy decision, with its unambiguously positive effect on the economy, could nonetheless bring confidence in the economy down another notch. But in the words of economist Alan Blinder, "if things are deteriorating as fast as [Fed Chairman] Greenspan must think, this will not be enough to stop the deterioration."
But the ultimate irony is that the biggest contributor to the surprisingly fast slowdown in the U.S. economy may be the actions of the Fed itself. Has the bite of high short term interest rates brought on by the restrictive central bank policies of the last two years been more than the economy could endure? It certainly didn't look that way last spring, coming off a year 1999 that saw double-digit spending growth on consumer durables, and payrolls growing by an average of 229,000 jobs per month.
But a substantial slowdown in growth began in earnest in the second half of 2000, particularly in those categories of business spending that are traditionally more responsive to rises in short term interest rates. Even the free wheeling spending of businesses on equipment and software, which had been on a double digit growth tear for several years running, came down to earth as the costs of short term borrowing and the tightening of credit began to be felt.
The early indications are that the slowdown in spending spread into the consumer sector in the last three months of the year. That's manifestly clear to the nation's automakers, who are reeling from a double whammy in the form of lower margins and lower sales. The 1.2 million cars and trucks sold in December represented the worst end-year performance for the industry in four years.
But if the bad news stopped there, we'd still be following the script sketched out by the Fed. After all, policymakers have been trying very consciously to get the economy to slow down, and given their determination, we shouldn't be surprised that the efforts are bearing fruit. But two additional situations have loomed larger in recent months, raising concern the economy may be carrying more baggage than it can safely handle: the deflation of the technology bubble, and the spreading tightness of the energy sector.
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