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[ The Atlanta Journal-Constitution: 6/26/03 ]

Fed sets interest rates lowest since '58

The Atlanta Journal-Constitution

Text of Fed's statement
Stocks fall after announcement

The nation's central bankers delivered a mixed message Wednesday by trimming interest rates yet again as if the economy needed help, but expressing confidence that recovery is coming.

The Federal Reserve's elite committee cut the benchmark short-term interest rate by 0.25 percent. That took the rate down to 1 percent -- a level last seen in July 1958.

The Fed committee said the cuts are "further support for an economy which it expects to improve over time."

Duke University economist Campbell Harvey said the Fed seemed to be saying two things at once.

"There's nothing that suggests the economy is taking a turn for the worse," he said. "So this is a confusing signal. In a way, it's a negative signal."

With a larger cut expected by some economists and investors, the move didn't please Wall Street. The Dow Jones Industrial average fell 98 points, while the tech-driven Nasdaq index slipped almost 3 points.

The latest rate reduction is certain to reverberate beyond Wall Street. Rate cuts ripple through the economy, fueling low-interest deals on appliances and autos. They often mean lower rates on credit card borrowing -- although some credit cards are near their minimum. They also further shave payments from money markets and other low-risk investments.

Partly because low rates squeeze lenders and hurt people who get much of their income from interest, some Fed studies have shown the benchmark rate should not fall below 0.75 percent.

That leaves the Fed nearly out of its traditional ammunition. After that, mostly untraditional methods remain -- like buying long-term bonds to keep mortgage rates low.

So far, lower rates have had limited success at moving companies to invest and hire. The economy has lost more than 500,000 jobs since the fall.

While Fed officials had predicted a postwar rebound from the Iraq invasion, signs of the pickup have been modest, though many forecasters see solid growth by year's end. Between tax cuts, federal spending and already low interest rates, a huge amount of stimulus is wending its way through the economy already.

Still, while 70 percent of corporate financial officers are optimistic, their companies are planning to expand investment by a mere 1.2 percent, according to a survey released this week by Duke's Fuqua School of Business.

Cutting rates for the 13th time during the economy's three-year malaise may add still more enticement, but it will not spur companies into long-delayed spending plans, Duke's Harvey said.

"It is hard to imagine that this is going to make any difference whatsoever," he said.

The Fed campaign to spur spending and kick the recovery into gear started in January 2001 when the benchmark interest rate was 6.5 percent. In some ways, Fed success has been spectacular.

The rate cuts fueled unprecedented sales in housing, with a record number of Americans now owning homes. And millions of Americans have used low mortgage rates to reduce house payments through refinancing.

Real estate has kept roaring. New-home sales in May jumped 12.5 percent to a record, according to data released Wednesday.

Sales of existing homes also were up, although just 1.2 percent. Applications for mortgages have stayed high, suggesting sales in June are still strong, said Maury Harris, chief economist for UBS Warburg.

Real estate is seen as critical to keeping the economy moving. And while the Fed does not directly control longer-term bonds on which mortgage rates are based, it urgently wants real estate to stay hot.

The Fed has flirted publicly with the idea of buying long-term bonds, which would keep rates low. But it has so far avoided that move in favor of talking, said economic forecaster Rajeev Dhawan of Georgia State University.

"They can only jawbone it -- and that has absolutely worked," Dhawan said.

But with modest signs of recovery emerging, even the smaller cut was not needed, Dhawan argued. "This was a compromise between what they should have done and what was expected."

The Fed knows the rate cut's economic effect is small, but they have other targets, like inspiring investor confidence, said Preston Martin, a former Fed vice chairman and now chairman of Martin Associates, a financial services firm.

"Because of the psychologies of the various markets, the Fed is giving a signal that they are continuing to stimulate economic growth," he said.

Moreover, the specter of deflation still hovers over the economy, and Fed officials have vowed to fight it aggressively, Martin said. "They are adding to the money supply four times as fast as the economy is growing. They are relaxing bank regulations. They are trying to stimulate the economy every way they can."


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2003 The Atlanta Journal-Constitution