Federal Reserve expected to lower interest rates; will it be enough?
WASHINGTON (AP) – The Federal Reserve, faced with an America gripped by fears of more terrorist attacks, is expected on Tuesday to push a key interest rate to its lowest level in four decades in an effort to get consumers spending again.
In the wake of the worst terrorist attacks in U.S. history, consumer confidence has plunged by the largest amount since the Persian Gulf War, an ominous development given that consumer spending accounts for two-thirds of total economic activity.
Wall Street, after two weeks of volatile trading, took a breather on Monday, awaiting the Fed’s next move. The Dow Jones industrial average closed down 10.73 points at 8,836.83.
Both of the major readings of consumer sentiment – done by the Conference Board in New York and the University of Michigan – show that confidence has been badly jolted by the attacks on the World Trade Center and the Pentagon.
The Conference Board reading fell by 14.4 percent in September, taking the largest one-month tumble since October 1990, when the United States was preparing to go to war against Iraq following its invasion of Kuwait.
The University of Michigan index of consumers’ expectations about the future fell to 73.5, a plunge of 13.7 percent from the August reading. The only two previous times that this index has fallen by similar amounts was the 1990 period leading up to the Gulf War and the 1973 Arab oil embargo.
Richard Curtin, director of the Michigan survey, said differences are significant between the short and successful Gulf War, after which consumer sentiment rebounded sharply, and the current, perhaps lengthy fight against an elusive foe.
”Fear is the new element for the U.S. economy. … This apprehension about domestic security and fearfulness of travel in general,” he told reporters Monday.
Before Sept. 11, the Fed had cut interest rates seven times in its most aggressive credit easing in nearly two decades as it tried to keep the economy out of a full-blown recession.
Most analysts had believed this campaign would succeed with the economy, which slowed to a barely discernible 0.3 percent growth rate from April through June, posting a solid rebound in the second half of this year.
But now with the extensive economic damage from the Sept. 11 attacks – from rising layoffs in the airline and tourist industries to rising consumer unease – many analysts believe the country is now in a recession which will probably last until the spring of next year.
David Wyss, chief economist at Standard & Poor’s in New York, said he looked for the Fed to cut its target for the federal funds rate, the interest that banks charge on overnight loans, by a half-point to 2.5 percent on Tuesday, the lowest level for this key interest rate since 1962. Wyss predicted another quarter point reduction at the Fed’s next meeting in November with further cuts possible.
While all this credit easing should be enough to revive the economy in the early part of 2002, Wyss said there is an unusual amount of uncertainty surrounding the economy at present.
”A lot will depend on how the war will play out and whether there will be more terrorist attacks,” Wyss said. ”We just don’t know.”
Treasury Secretary Paul O’Neill now believes that the gross domestic product – the total output of goods and services – could drop into negative territory in the just-completed July-September quarter, Treasury spokeswoman Michele Davis told reporters on Monday.
But he still believes that growth can resume in the fourth quarter, ”if we take the appropriate policy steps,” Davis said. The administration is preparing a new economic stimulus package that will include extra spending and tax relief for individuals and businesses to fight off a recession.
Even if the country does suffer a recession – traditionally defined as two consecutive quarters of falling GDP – most analysts are looking for a rebound at least by the second half of next year, fueled by the Fed rate cuts, tax reductions and increased government spending.
”Given all that stimulus, it’s hard to see how the economy won’t respond strongly,” said Bruce Steinberg, chief economist at Merrill Lynch. He forecast the GDP would shrink at an annual rate of 1 percent in both the third and fourth quarters of this year but will resume growth of 2.2 percent in the first quarter of next year.
Because of their expectation of a rather mild recession, analysts believe the unemployment rate will top out at around 6 percent. It has already risen from a three-decade low of 3.9 percent to 4.9 percent in August.
On the Net:
Federal Reserve: http://www.federalreserve.gov
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