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Politics : Idea Of The Day -- Ignore unavailable to you. Want to Upgrade?

To: IQBAL LATIF who wrote (21312)	11/15/1998 9:21:00 AM
From: IQBAL LATIF	Respond to of 50167

Should Greenspan cut rates or sit tight for now? The case for further cuts next week is tentative on either side of the ledger By Michael Weinstein FINANCIAL turmoil makes every meeting of the United States Federal Reserve Board an occasion for frenzied speculation about interest rate cuts. Wall Street turns out daily tomes of advice, mostly calling on the Fed to knock rates down a few pegs. "Don't stop treatment until the patient is cured," Robert Barbera and Jose Rasco of Hoenig & Co, for example, recently warned the Fed. "We see additional ease as absolutely necessary to prevent deflationary pressures." Strong words. But the simple fact is that nothing the Fed decides at its next meeting, on Tuesday, will matter very much. Not that the Fed isn't very important in setting the monetary climate for the economy. But if it moves at all, it will surely move very little. No one need lose sleep worrying about whether the Fed will stand pat or drop short-term interest rates another quarter percentage point. The Fed's basic problem is that economists never know whether a recession is around the corner. Nor can they pinpoint the impact of cuts in short-term interest rates -- the only ones the Fed controls -- even on long-term rates, much less on spending, prices and employment. That puts Fed chairman Alan Greenspan and his colleagues in the position of guessing a lot. No wonder Mr Greenspan's testimony invariably retreats into amorphous conversation about balancing of risks. In an unpredictable world, the Fed deliberates which course of action -- in next week's case, a small easing or standing pat -- poses the graver economic risk. The case for cutting rates starts with the fact that the economy is slowing and could use a nudge. Exports of tractors and other manufactured goods are plummeting. Employment in manufacturing fell by 50,000 jobs last quarter, and has shrunk by more than 200,000 since January. Service jobs are picking up the slack, but growth is expected to fall to around 1.5 per cent. Meanwhile, productivity rose at a gaudy annualised rate of 2.3 per cent last quarter, meaning that companies can raise wages without having to raise prices -- a brake on inflation that gives the Fed room to ease. The best case for easing is made by Professor Alan Blinder of Princeton, a former vice-chairman of the Fed. Prof Blinder concedes that the Fed's two earlier rate cuts this year have calmed financial markets. A measure of investor fear -- the gap between interest rates that investors charge risky corporate borrowers and safe government borrowers -- has shrunk since Mr Greenspan by word and deed told investors he would not allow the economy to starve for credit. But the gap, Prof Blinder says, remains well above the historical norm for an economy that continues to grow respectably. Prof Blinder focuses on the "real" federal funds rate, which subtracts the expected rate of inflation from the interest rate that banks charge one another for overnight loans. Today, the real funds rate is, by his analysis, quite high, in excess of 2.5 per cent. "That puts a mild tug on growth," he said. The tug made sense when the economy was roaring along. But "now that the economy is visibly slowing," Prof Blinder said, "it is appropriate to turn the Fed's mild tug on the economy into at least a neutral stance whereby monetary policy is no longer holding the economy back." Still, he is not calling on the Fed to do anything bold. He notes that there is a risk of too much monetary ease, primarily in the fuelling of a still-overheated stock market. Professor Benjamin Friedman of Harvard University makes the best case for standing pat. He does not strongly oppose a quarter-point rate cut. But neither is he enthusiastic. "The problem of the American economy -- investors that are too scared to lend -- will not be cured by modest interest rate cuts," he said. Prof Friedman fears that investors are coming to depend on a steady diet of rate cuts, in which case the Fed risks trapping itself either in meeting those expectations or touching off a harsh response on stock and bond markets if it disappoints them. "If one cut leads to another," he added, "the Fed will wind up cutting rates by a percentage point or more, satisfying the expectation of bond traders along the way but risking overstimulating the economy and driving the stock market to unrealistic new highs." Frederic Mishkin of Columbia University says that rising stock prices and low unemployment rates weaken the case for easing. He applauded Mr Greenspan for moving early to ward off the impact of financial turmoil abroad, thus proving "that the Fed would not repeat the mistakes of Japan, where monetary authorities have sat back while the economy sank". But, he warns, the threat of inflation should not be casually dismissed. "The Fed has sometimes overly stimulated the economy when it was weak and triggered rising inflation that eventually forced the Fed to crack down hard, sending the economy into reverse," he said. Using Mr Greenspan's terminology, Prof Mishkin concluded that "the current balance of risks is balanced". The upshot is that the case for further cuts next week is tentative on either side of the ledger. Indeed, even the Wall Street experts who call on the Fed to cut rates to save the economy may exercise a different judgment when they invest. Based on bets that investors are making on the course of federal funds rate in the next several weeks, Bridgewater Associates calculates that investors set the probability of a Fed easing next week at about 50 per cent. Apparently, when Wall Street experts vote with money, they judge the case for Fed easing a toss-up. -- NYT