Fed move would bring interest rates to 40-year low

Tomorrow, in an effort to revive an economy now traumatized by the Sept. 11 terrorist attacks, the Federal Reserve is expected to push short-term interest rates down to a level not seen since the early 1960s.

It would be the ninth time this year the Fed has cut rates, and, given the precarious state of the economy, many economists say it won't be the last time.

The recent attacks, coming as the US and world economies were already slackening, have shaken consumers and businesses alike and thrown the timing of a rebound into doubt.

Against this backdrop, Wall Street expects the Fed to cut short-term interest rates by half a percentage point tomorrow, meaning banks would charge each other interest of just 2.5 percent on overnight loans, down from 6.5 percent at the beginning of the year.

"One of the most aggressive easing campaigns ever undertaken," says Tom Schlesinger, director of the Financial Markets Center in Philomont, Va.

The Fed already made an emergency cut of half a percentage point Sept. 17 and has pumped huge amounts of liquidity into the financial markets since the disaster. So some economists say a quarter-point cut would be appropriate tomorrow.

Stock market investors, though, might be disappointed and drive share prices lower.

In either event, short-term rates below 3 percent have not been seen since 1962, when William McChesney Martin presided at the Fed. At that time, consumer prices were rising less than 1.5 percent a year.

Consumer prices today have been increasing at about a 3 percent rate. Thus short-term money will be in real terms free - costless to borrowers after inflation. And it is widely assumed that the Fed will cut rates again when its policymakers again meet Nov. 6.

The Fed's actions, combined with a big drop in oil prices and federal moves to cut taxes and boost spending, should pull the economy out of its doldrums in the first or second quarter of 2002.

"We may see a snapback sooner and stronger than people now anticipate," says Paul Kasriel, an economist at Northern Trust Co. in Chicago.

Others, however, paint a more sobering picture.

"The outlook in the short term is serious, and ... we will most likely have to wait until the end of 2002 until we see an economic upturn in the United States," Goldman Sachs chief Henry Paulson said in Germany's Der Spiegel yesterday.

While Washington is moving aggressively, some economists worry that other nations are not responding strongly enough.

Despite all the concerns about world recession, the inflation-wary European Central Bank failed at a policy session last week to drop its interest rates again.

In the previous week, the ECB had joined the Fed and other central banks in a coordinated easing of monetary policy.

To many economists, the Bank of Japan has been tardy and overly tight, not adequately combating a decade-long slump.

While conducting a dramatic monetary policy, Fed Chairman Alan Greenspan has been urging caution on Congress in regard to further tax cuts and spending. It should wait for more data about the economy's current health before deciding whether to a adopt a new stimulus package, he says.

The tax rebates, devised by the Progressive Caucus in Congress, injected $40 billion into taxpayers' pockets this summer. Another $70 billion of tax relief is already scheduled for 2002 in the Bush tax cut.

Should more need to be done fiscally, Greenspan suggested a $100 billion program - 1 percent of gross domestic product - should do the trick. That sum would include the $55 billion or so that Congress has already appropriated for its emergency defense and recovery efforts and the airline bailout.

If Congress heeds Greenspan, it could add with his blessing $45 billion in tax cuts or expenditures. But Congress is expected to take a few weeks to hammer out such a package.

The economy may need pump-priming, says Martin Baily, chair of President Clinton's Council of Economic Advisers. "But let's not do things that undermine long-run fiscal stability," he says. "We should set as a goal saving the Social Security surplus."

Despite the efforts of Republicans and Democrats to tackle fiscal issues in a bipartisan fashion because of the Sept. 11 tragedy, legislators do have genuine differences on these policy matters. Washington observers expect these disputes to reemerge in coming weeks.

In the meantime, economic data show a mixed picture.

With consumer confidence now down sharply, "a recession is no longer in doubt," holds Richard Curtin, director of the survey. "The only issue is how long the downturn will last."

Optimists see several factors pointing to recovery.

By one measure, the nation's money supply has been growing at a torrid 12.5 percent annual rate. That represents fuel for future growth. Oil prices have plunged below $23 a barrel.