HOW LOW CAN RATES GO?
BY JULIANNE MALVEAUX
When the Federal Reserve Board's Open Market Committee cut the federal funds rate half a point to 4 percent on Tuesday, some expected the stock market to react with the irrational exuberance Board Chairman Alan Greenspan so eagerly discusses. Instead, the market shrugged at the fifth interest rate cut of the year, even though rates are 2.5 percent lower than they were at the beginning of the year. The Fed has been aggressive in cutting rates, since it is one of the few ways they can nudge the economy into recovery. But it takes between six and eighteen months, generally, for rate cuts to take effect. If the past is prologue, there won't be economic recovery any time soon. Instead, one could argue that interest rate hikes of a year ago are partly responsible for the current slowdown.
Still, people are expecting another short-term interest rate cut next month when the Fed meets on June 26 and 27. There is speculation that the interest rate cut will be just a quarter of a percentage point, just as there was before Tuesday's meeting. But, like Tuesday, the Open Market Committee may decide to cut the rate half a point in its attempt to jump-start the economy. If the rate gets down as low as 3.5 percent, the fed severely limits its ability to cut rates in the future. How low, after all, can interest rates go?
Bankers responded predictably to
the cut in short-term interest rates,
cutting the prime rate to 7.5 percent. Mortgage rates aren't likely to drop,
though, as they have been falling in anticipation of the Fed's rate cut, and
as long-terms rates don't always respond to short-term rate cuts. Thus, if
the Fed hoped to stimulate home buying with its rate cut, that isn't likely
to happen. Instead, businesses will find the cost of funds is likely to
fall, hopefully stimulating business investment.
Interest rate cuts don't offer much to the average consumer. Credit card interest rates aren't likely to be cut in response to the federal funds rate cut. As consumers keep spending, despite a weakening economy, credit card companies are doing very well by adding late fees and surcharges to already sky-high interest rates. (Some cards have interest rates as high as 22 percent, and others charge as much as $30 for late payments). The average consumer, then, is at risk of layoffs and higher unemployment but gets little from the economy-stimulating move of interest rate cuts.
But then the Fed has never been especially interested in the average consumer, just the average investor. While the number of investors has certainly risen during the last decade, though, still half of all Americans aren't in the stock market. We rely on their spending to fuel economic expansion, but we ignore the impact an economic slowdown may have on them. Unless the tax cut is structured to provide some relief to those with incomes below $30,000, those at the bottom will only get the "trickle down" break that comes if businesses respond to them, which is not likely.
I don't think that Alan Greenspan wants to wait months to see if his rate cuts are working. It is likely that the Fed will cut rates again in June, and again later in the summer as Greenspan sees the need for continued economic stimulation. But once the federal funds rate drops to 3 percent, banks are likely to squawk at further interest rate cuts, since lowering the price of money clearly cuts into their profits. Greenspan and his cronies on the Fed have only a few arrows left in their quiver, and they'll need to use them carefully.
While it is not the Fed's job to be concerned with issues of poverty and income distribution, it would be useful if Greenspan and his group addressed themselves to the impact their rate cuts have on a cross-section of the population. If they acknowledge that their actions only benefit a limited number of people, they may pressure Congress to pay attention to ways they can offer relief to those at the bottom, many of whom benefited little for economic expansion, but are already feeling the pinch of the economic slowdown. While an expanding economy benefits us all, some are greater gainers than others. It's good economic policy to attempt to distribute the gains more evenly. Cutting the interest rate won't change the way that gains are distributed; they may not even provide the economy with the stimulation it needs. But the Fed can acknowledge distributional issues and urge Congress to deal with them.