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Interest rates: a mind game
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CHAIRMAN of US Federal Reserve Alan Greenspan announced last week a second half-per cent interest-rate cut in a month to revive an apparent economic slowdown, which the Wall Street Journal describes as shocking and palpable.
Though most economists believe cutting interest rates is a way to stimulate the economy, this fast move certainly has caught some off guard. Indeed this is the second interest rate cut in one month and an unusual move for Alan Greenspan, whose preferred tempo has always been adagio. In fact US Federal Reserve has not cut interest rates that fast since 1982, when the US economy was in the middle of the worst recession since the 1930s.
Looked in another way, even in the middle of the 1990 recession, it took the Fed two months to cut one percentage point. And now interest rates are 15 per cent lower than they were just one month ago.
Some US economists say the recent cut over-reacts to the current economic slowdown, citing that the US economy still shows remarkable health including a jobless rate at four per cent, a 30-year low. Moreover even with the end-of-year slowdown, US economy grew a sizzling five per cent last year, the strongest annual growth rate since 1984. Productivity remains strong. The federal government's fiscal outlook is bright with this year's budget surplus expected to top US$280 billion.
Mr Greenspan's major concern, however, is consumer confidence, which is considered to be the driving power for US economic development. He noted in his testimony last week that a lack of consumer confidence can turn short, relatively painless recessions into longer, more miserable ones. "It is important that we avoid that," he said.
Recent surveys that US consumer confidence has slid to a four-year low, taking its biggest hit since 1990 recession. Though the surveys say consumers have yet to feel the pain, they indicate that worse times may loom ahead. The surveys also say business confidence also hit its lowest point since 1980.
The cut is certainly welcome news. It means that borrowing costs for families and businesses will be falling. In time, this will have a positive effect. But some economists suggest the cut should have come earlier to avoid this recession.
US Federal Reserve is now being blamed for failing to read the economy. The Fed began raising interest rates in mid-1999 because it believed it saw warning signs of inflation. Two things in particular were of concern. First the skyrocketing stock market put inflationary pressure on the US economy through "the wealth effect". The second factor the Fed was concerned about was the rapid growth in GDP and low unemployment. With real GDP up almost six per cent and unemployment rate down to just over four per cent, the Fed believes that inflationary pressure was real.
Some analysts say that the recent rapid interest-rate cut came as a result of the previous interest lifts. An influential US economist named Grian Wesbury said that this manly confidence-driven recession is a natural result of an industrial economy moving toward the information age. He said that with information technology readily available, information travels fast and the market reacts in the lightening speed. But the transformation from the industrial age to the information age takes a long time and brings with it wrenching changes.
Mr Wesbury's argument is explained by large-scale lay-off in anticipation of the economic slowdown. With eroding confidence, many investors and business leaders act as though they were in real recession, he said.
The recent interest-rate cut will also have a wider impact on the global economy. Economists say the cuts may lead to weakening of the US dollar. As most commodities at the international markets are priced in the US dollar, devaluation of the US dollar may lead to price changes of many commodities, exerting a global impact.
As the cut lowers the reward of putting money in the US banks, it may reduce the flow of capital into the US. It may also lead to outflow of capital from the US. For Asian countries that have suffered from capital speculation during the Asian crisis, a warning signal is raised for financial attacks by international flowing capital.
On the other hand, as the United States major trade partners, a weakening US economy and weakening US dollars will certainly affect the income of Asian exporters to the US. (SD-Agencies)
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