Suddenly, Less Pressure on the Fed

After The Fall

Poof! Nearly $600 billion of the value of individual American investors' stocks disappeared in several hours Monday. The market waved its hand again Tuesday, and, poof, half of that worth was back in their portfolios.

It was like a magician's show, a scary performance watched with fascination by millions in the United States.

Some people suffered real losses on stock sales; others just experienced a paper loss in their portfolios.

The Wall Street temblor could have another impact on pocketbooks. It will likely help keep interest rates down, saving Americans money on loans made to buy houses, cars, and appliances.

That's because the ups and downs of the market are followed by a group having much to do with the future of the US business cycle - the 18 members of the Federal Reserve's policymaking committee.

They want the economy to slow down. Fed Chairman Alan Greenspan says its present pace is "unsustainable." Spurred in part by the "wealth effect" - a tendency for investors to spend more when they have fat stock portfolios, the economy has put so many of the jobless to work that labor shortages are appearing.

But will the market correction discourage consumer and business purchases enough to keep the Fed from hiking interest rates?

Mr. Greenspan himself told the Joint Economic Committee of Congress Wednesday, that the decline could be "a salutary event" for the overall economy: "The market's net retrenchment of recent days will tend to damp that impetus, a development that should help to prolong our 6-1/2-year business expansion."

Private economists are split on the likelihood of a slowdown

"The US economy will be at best experiencing much more sluggish growth," says Philip Braverman, chief economist at DKB Securities (USA) in New York.

Contrariwise, Stephen Roach, chief economist at Morgan Stanley Dean Witter in New York, writes that he is "hard pressed to believe that the wrenching, but relatively minor, drop in share prices of the past few days will have any impact whatsoever on the real economy or the inflation outlook in 1998."

At the closing of the market last Monday, the Standard & Poor's 500 average was down about 15 percent from its peak early in October. By the end of the week it was down only 6 or 7 percent.

"A correction has to take a little longer than a quick down day," says Michael Flament, chief economist at Wright Investors Service in Bridgeport, Conn. "It has to have consequences."

He doubts consumers will be more cautious in their spending as a result of last week's market slump.

Nonetheless, unlike Mr. Roach, he sees the economy slowing already, Further, the troubles in the Asian economies will have an impact on the US. He now predicts 2 percent real growth in the output of goods and services next year, down from the 2.5 percent he had previously counted on.

"Alan Greenspan should be thrilled if that's the case," he says. "It makes inflation a little less likely and Fed tightening a little less likely."

Without the stock market boom, Mr. Braverman argues, growing consumer bankruptcies and credit-card delinquencies and defaults, plus tougher bank and credit-card company standards for consumer loans, would have led to a recession or near recession. But this was swamped by the spending of those in the securities industry and top corporate managers enjoying spectacular earnings.

If stock prices merely gyrate in coming weeks, these credit problems will attract more attention, he adds.

Braverman expects the Fed's 0.25 percentage point hike in interest rates last March to affect the economy now. He regards interest rates as high if inflation is taken into account. Currency devaluations in Asia, he adds, will lower the cost of imports in the US, restraining inflation.

Growth will be moderate enough "to calm everybody." So the Fed will ease interest rates next year, he forecasts.

By contrast, Roach expects the Fed to push up interest rates by one percentage point at least in 1998. "The Fed," he figures, "will shortly run out of patience in waiting for that ever-elusive slowdown."

The latest statistics offer no firm answer as to which economist is right.

National output was up at an anticipated 3.5 percent annual rate in the third quarter. New home sales in September were weaker than economists expected.

Labor costs rose 0.8 percent in the third quarter and 3 percent over the last year. "There are no labor pressures in the inflation pipeline," notes Stan Shipley, a Merrill Lynch economist.

New orders for durable goods - refrigerators, electronic goods, aircraft, etc. - declined 0. 6 percent in September.

Given the stock market decline, economists overwhelmingly expect Fed policymakers to keep interest rates steady when they meet Feb. 12.

The fact that for almost a year Greenspan has been trying to restrain equity prices is unusual. Stock markets, notes David Hale, an economist at Zurich Insurance Group in Chicago, "have not played a decisive role in the monetary policy of the US or most other industrial countries during the modern era."

Central banks have lowered interest rates after stock market crashes, as the Fed did in 1987. But, adds Mr. Hale, there is no precedent since the late 1920s, before the 1929 crash, for the Fed to actively try to restrain a stock market as Greenspan has apparently tried.

The Dow Jones Industrial Average, however, stood at 7442.07 at the close of trading Friday, still up 1,005 points from the 6437 level on Dec. 6, 1996, the day he asked his now-famous question about whether stock prices reflected "irrational exuberance" of investors.