Slow Recovery Likely, Despite Interest Cuts
Analyst: `The US economy just doesn't turn on a dime'
MINDFUL of this year's economic slide and next year's presidential elections, the Bush administration was buoyed by the Federal Reserve Board's surprise decision this week to cut interest rates. As enthusiasts for ``growing out of recession,'' administration officials say they believe lower rates will renew activity and help meet challenges from the Democrats to focus on domestic economic issues.
Michael Boskin, chairman of the president's Council of Economic Advisers, remains firm in forecasting United States economic revival by next month, a view not shared by many leading private economists. They question whether lower rates, designed to make borrowing cheaper, are enough to spur economic growth.
Allen Sinai, chief economist for the Boston Company, says the ``Fed easing recognizes that the economy continues to sink and a midyear recovery is very unlikely. The US economy just doesn't turn on a dime.''
Several top commercial banks reacted to the Fed action this week by cutting their prime lending rates half a point to a three-year low of 8.5 percent. The prime rate is a standard by which other consumer-oriented loan rates are set.
``Lower interest costs for banks, households, and businesses, won't bring a lot of borrowers to the table,'' Mr. Sinai says.
A reduction in the prime rate will push mortgage rates down, he says, ``and that will give some relief to households' monthly burdens and free up some cash.'' That freed cash, or disposable income, should provide consumers with more money to spend. ``That's the hope for economic recovery. Consumers can hardly spend less than what they spent in the last two quarters,'' Sinai says, noting the past six months of decline in consumption.
Public trepidation last summer and fall over an impending Persian Gulf war and plummeting consumer confidence resulted in a dramatic drop in consumer purchases. Consumer spending represents two-thirds of the US economy.
The business reaction has been to weaken activity, says Gail Fosler, chief economist of the Conference Board, ``and that dramatic cut in output'' takes its toll on joblessness. Many labor economists project that unemployment will hover around 7 percent for the next several months. That high rate, and the lost wages it implies for people without work, will work against any added disposable income.
``The only instrument we feel we can use is a fall in interest rates,'' she says. ``But just because you lower your rates doesn't mean you can make people borrow, and banks haven't signaled that they want to lend. They are risk-averse and want to assure appropriate collateral.'' Ms. Fosler cites one business that had to put $200,000 down for a $100,000 letter of credit. Seeking credit actually eats into working capital, she says.
In the current climate, businesses view inventories as something to control, not to build. ``Overall corporate profits are basically flat with where they were a year ago. No one wanted to be caught with unwanted inventory that would have to be discounted'' to sell it off, Fosler says.
Borrowing for capital expansion and increased production is at a low ebb. For good reason, Fosler explains, ``nondefense orders for capital goods is 16 percent below the spring 1990 level.'' Little capital is sought for new businesses, as the existing business failure rate is high.
With a dramatic downturn in consumer demand for autos, the nation's three leading car makers - General Motors, Ford and Chrysler - reported this week huge first-quarter losses of more than $2.5 billion, collectively. Industry analysts don't expect the companies to post profits until at least the fourth quarter.
The limping economy will show ``that another dose of easing from the Fed will be necessary,'' Sinai says. ``Economic recovery will not begin until the fourth quarter of this year - Labor Day, at best.''
William MacReynolds, director of forecasting for the United States Chamber of Commerce, says: ``Even if the recovery starts in the fourth quarter of 1991, it will be small ... and will not stop the unemployment rate from increasing.'' He attributes the current recession to ``the decidedly antigrowth stance of the federal government'' and ongoing constraints - which he says include costly environmental and health-care standards, regulations that tighten credit and stifle small- and medium-business growth , and higher taxes that chip away profits and spending power. The economy can expect only an ``anemic recovery in 1992,'' he says.
As part of its ``growing out of recession'' strategy, the Bush administration has banked on increased US exports. ``They've been growing strong,'' Fosler says. ``At 15 percent of the US economy, exports aren't not big enough to forestall recession, but they help provide economic stability.'' The Fed's rate cut lowered the value of the dollar on foreign exchange markets, which makes US goods abroad more competitively priced.
US Treasury Secretary Nicholas Brady failed to convince the world's leading finance ministers, gathered in Washington this week, to combat world recession with lower rates. By lowering interest rates at home, Sinai says, ``the Fed set the ball rolling to move world interest rates down.''