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As spending ebbs, Fed set to act

The Federal Reserve is expected to cut interest rates by a quarter point Wednesday.

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The Federal Reserve wants to send a message to both Wall Street and Main Street: We don't want to see the economy slide into a recession next year.

On Wednesday, that message is likely to be punctuated by a second consecutive drop in interest rates – this time a quarter-point reduction.

The potential interest-rate cut would mark a shift toward a more forward-looking central bank. Although the Commerce Department is expected to report Wednesday that the US economy grew by a 3 percent annual rate in the quarter that ended last month, economic growth for the current quarter is expected to slow to less than 2 percent. In addition, economists don't anticipate that the economy will get much of a boost from holiday sales, which are projected to grow a modest 4 percent from last year.

Economists thus consider a rate cut by the Fed to be like an insurance policy that could help prevent a potential economic slowdown next year.

"If I were there, in the Fed's boardroom, I would be voting for a further reduction," says Lyle Gramley, an economist and former Fed governor. "The risk to the economy is for further weakening."

One major change taking place: tightening financial conditions, says Mr. Gramley, now a senior economic adviser at the Stanford Washington Research Group. Because of losses in the mortgage market, banks have tightened their lending standards in almost all categories.

In polls, the Gallup Organization has found that 1 in 6 people knows someone who has been turned down for credit, says Dennis Jacobe, Gallup's chief economist in Washington. "We expect that to increase: It takes a while for people to realize standards are tougher," he says. "There is still quite a ways to go on the unfolding impact of the financial crunch."

This may be a reason why consumer surveys show confidence declining. In the past three months, the consumer sentiment survey by the University of Michigan is down 11 points. Economist David Rosenberg of Merrill Lynch & Co. writes that such drops have typically happened around events such as hurricane Katrina or the start of the Iraq war.

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