After yet another big interest rate cut by the Fed, consumer's behavior remains the unanswered question in economy's future

Wednesday, October 3rd 2001, 12:00 am
By: News On 6

WASHINGTON (AP) _ The Federal Reserve's latest attempt to cushion the economic blow from the terror attacks probably will be followed by additional interest rate reductions in the months ahead.

Economists still are uncertain about how consumers, who hold the key to a recovery, will respond.

With Tuesday's one-half percentage point cut, Fed Chairman Alan Greenspan and his colleagues have pushed the target for the federal funds rate to 2.5 percent, the lowest level since May 1962 for the interest banks charge each other on overnight loans.

It was the second reduction of half a point since the Sept. 11 attacks and the ninth time the Fed cut rates this year.

``The terrorist attacks have significantly heightened uncertainty in an economy that was already weak,'' the Fed said, explaining its latest action. ``Business and household spending as a consequence are being further damped.''

After the Fed's announcement, a lackadaisical stock market picked up some steam. The Dow Jones industrial average closed up 113.76 at 8,950.59, the gains coming chiefly in the last hour of trading.

But on Wednesday the Dow lost some ground. Profit warnings from Eli Lilly and Nortel Networks helped to push the industrials down by 32 points in the first hour of trading.

Before the attacks, consumers, whose spending accounts for two-thirds of the nation's economic activity, were a key force keeping the economy out of recession. With consumer confidence plunging and layoffs spiking since the attacks, however, economists worry that consumers will close their pocketbooks.

``Consumers hold the key to the economic stability of the country,'' said Martin Regalia, chief economist for the Chamber of Commerce. ``If consumers continue to lose confidence in the economy, and thus refuse to spend, the hopes of a quick rebound in economic growth look bleak. But if consumer confidence rights itself, growth could turn around swiftly.''

Most economists, in the wake of the attacks, have given up hope for a rebound this year. Many believe a recession is now inevitable, although some expect the Fed's rate reductions to keep the downturn from being drawn out.

And, for the first time, a top member of President Bush's economic team Tuesday used the word ``recession'' to describe the country's present circumstances.

R. Glenn Hubbard, chairman of the president's Council of Economic Advisers, told Congress that the loss of life, the blow to the financial sector and the disruption of airline service ``increase significantly the likelihood that the economy is in a recession.''

Many economists believe the economy, which had slowed to a barely perceptible growth rate of 0.3 percent in the April-June quarter, probably will decline at annual rates of 1 percent in the July-September and October-December quarters.

In response to the Fed's cut, commercial banks reduced their prime lending rate, the benchmark for millions of consumer and business loans. That rate fell to 5.5 percent, a level last seen in October 1972.

``The catalyst for the economy to get out of recession depends as much on the psychological realm as the financial realm,'' said Stuart Hoffman, chief economist at PNC Financial Services Group.

The Fed also cut its discount rate, the interest it charges to make direct loans to banks, to 2 percent, the lowest level since November 1958. The central bank has used its discount window to pump out billions of dollars in direct loans to banks since the attacks to keep the financial system operating smoothly.

Even with aggressive credit easing by the Fed, analysts predicted more cutting of the federal funds rate to come, with many looking for half-point reductions at the Fed's final two meetings of the year Nov. 6 and Dec. 11.

``No policy-maker is willing to take a chance of getting behind the curve of what could be a significant drop in consumer spending and therefore a big drop in national output,'' said economist Clifford Waldman of Waldman Associates.

Bush, meanwhile, is working with leaders of Congress to put together an economic stimulus package of tax relief for businesses and individuals and increased government spending.

Treasury Secretary Paul O'Neill said Wednesday that President Bush wants Congress to approve a stimulus plan of between $60 billion and $75 billion.

Many analysts are hopeful that the Fed's credit easing and economic stimulus from the government will set the stage for a rebound in the second half of next year.