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Fed stands at a crossroads
The Federal Reserve's elite committee meets today, its quiver of rate cuts nearly empty as it faces an uncertain, war-rattled economy.
With its benchmark rate already at 1.25 percent --- a 40-year low --- the Fed must decide whether the economy has suddenly weakened and whether one more cut would lead to the ever-elusive recovery.
Moreover, the Fed must also consider the timing: Should a move await the outcome of the expected war with Iraq?
While expectations are climbing that the Fed will cut rates again, most economists think this meeting will end with rates unchanged. But another rate change is expected --- perhaps at the Fed committee's next meeting.
"The downside of waiting six weeks is not very large," said former Fed economist Christopher Carroll, professor of economics at Johns Hopkins University in Baltimore.
Fed Chairman Alan Greenspan has said that the economy is fundamentally sound and that economic recovery will follow a resolution of the Iraq crisis. With the United States now poised to launch an attack, Greenspan will argue to wait, Carroll said.
"Knowing Greenspan's decision-making process and having heard what he has said recently, I would guess that he just wants to see what happens."
The Fed can change rates between meetings, too.
The start of war could spin the economy off the rails, calling for a dramatic Fed response. But the effect could be the opposite, Carroll said.
"You could get a big surge in the stock market. You could get an uptick in consumer confidence and spending. And then if you have already made a move, you might regret it."
The economic downturn began in 2000 and slipped into recession in early 2001, according to the group in charge of designating recessions, the National Bureau of Economic Research. The economy stopped contracting in late 2001, but since then, growth has been erratic. Companies continue to shed jobs, and consumer spending has been clipped back.
Talk of a "double dip" back into recession has again surfaced, even among some mainstream economists. In fact, the bureau has yet to declare the recession over.
To fight sluggishness, one of the Fed's prime weapons is the rate cut, which makes borrowing cheaper for companies and consumers. When it sensed the economy weakening in 2001, the Fed began a series of a dozen rate cuts.
Those cuts are widely credited with fueling auto sales and pulling down mortgage rates, key to the boom in housing purchases and refinancing.
Fed rate changes ripple slowly through the economy, taking nine months or more to have their full effect. But aggressive moves by the Fed also have their immediate psychological impact --- positive or otherwise.
Fed cuts are often embraced on Wall Street. But after months of Fed praises for the economy's health, a rate cut meant to be reassuring could instead be unnerving, argued economist Campbell Harvey of Duke University.
"People will see it as a panic situation. If they take it below 1 percent, that will look like a panic move."
WIDENING EFFECT: Rate cuts by the Federal Reserve directly affect only a small group of huge lenders and borrowers, but the changes ripple across the economy. Indirectly, Fed actions changes the price of loans for buying cars and homes.
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© 2003 The Atlanta Journal-Constitution