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Fed Again Acts to Push Down Interest Rates : Economy: The central bank's action to cut the rate banks charge each other for overnight loans indicates concern that a deep recession is brewing.

December 20, 1990|JAMES RISEN | TIMES STAFF WRITER

WASHINGTON — In another sign of its deepening concern over the threat of a severe recession, the Federal Reserve Board moved to cut interest rates again Wednesday, helping to push down the federal funds rate to just over 7%.

The action, which followed a policy-making meeting at the Fed, marked the fourth time in two months that the central bank has moved to lower the federal funds rate, the rate that banks charge each other for overnight loans. It came just a day after the Fed's more visible reduction of half a percentage point in the discount rate, the rate the Fed charges for loans to commercial banks, to 6.5%.

The Fed has now pushed down the federal funds rate by a full percentage point from its level just before the Aug. 2 Iraqi invasion of Kuwait. It dropped by nearly a quarter of a percentage point Wednesday, to 7.06% late in the day, from 7.25% late Tuesday. The Fed influences the federal funds rate by aggressively purchasing Treasury securities, thus injecting money into the markets.

The decision to follow Tuesday's discount rate reduction with a quick move on the federal funds rate came amid further signs that the economy is even weaker than economists had previously believed.

On Wednesday, the Commerce Department issued a revised report that showed that the economy's output of goods and services grew at a slower pace in the third quarter than earlier reported. The government said that the Gross National Product for the third quarter rose at an annual rate of just 1.4%, down sharply from an earlier estimate of 1.7%. The new figure represents the second and final revision of GNP for the three-month period.

Most economists now believe that the GNP figures will turn negative in the fourth quarter, marking the onset of a recession, which is technically defined as two consecutive quarterly declines in GNP.

The government also issued a pessimistic report on the housing industry Wednesday, reflecting the worsening slump in many of the nation's real estate markets. The Commerce Department said that new starts of single-family homes fell 9.8% during November to their lowest levels since the recession of 1982. An increase in starts of apartment buildings and condominiums inflated the overall housing figures for the month, however. Total housing starts rose 9.3% on the strength of the rise in the volatile multiunit market.

The bearish economic figures are leading some prominent economists to argue that the Fed's aggressive moves are still not enough to jump-start the economy. They believe that with the economy so weak, lower interest rates will not fan inflation. As a result, they are urging the Fed to continue to cut rates.

"Most analysts would agree that we are in a recession right now, so I think the Fed has to keep pushing hard on interest rates," said Martin Feldstein, the director of the National Bureau of Economic Research in Cambridge, Mass., and former chairman of the Council of Economic Advisers under President Reagan.

"The Fed is moving in the right direction, but the question is whether they are moving fast enough to avoid a very severe contraction," he added.

But despite that criticism, the Fed has now used virtually every monetary policy tool at its disposal in the past few months in order to reverse the economy's slide. Besides cutting the discount rate and the federal funds rate, the Fed has also reduced reserve requirements banks must meet to back up certain types of large deposits. That action effectively frees up billions of dollars in the banking system to increase lending activity.

Some economists warned that the nation's money supply, a key piece of economic data closely monitored by the Federal Reserve to determine the threat from inflation, is now growing so slowly that inflation should no longer be a serious concern for economic policy-makers over the next few months. In fact, money growth has nearly ground to a halt, which could signal a sharp credit contraction in the banking system.

The weakness in the banking system, many economists believe, may prolong the recession. As banks seek to rebuild their balance sheets by curtailing their lending, they are proving reluctant to reduce their interest rates to match the Fed's reductions. The prime lending rate, the rate banks charge their best corporate borrowers, has remained unchanged at 10%, despite the cuts in both the discount rate and the fed funds rate. Economists say the spreads between the interest rates charged by banks and the rates they now must pay the Fed for funds are extraordinarily large.

That broad spread helps increase the profitability of commercial banks. But if the banks continue to refuse to cut their rates, the Fed's ability to have an impact on economic activity will be limited.

DOUBT VOICED:Some analysts doubt that recent Fed actions will succeed in heading off arecession. A1

Housing Starts Seasonally adjusted annual rate, millions of units Nov., '90: 1.13 Oct.,'90: 1.03 Nov., '89: 1.35 Source: Commerce Department GNP Precent change from previous quarter 3rd quarter (revised) 1.4% Source: Commerce Department

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