Have rate cuts lost kick?

Associated Press

WASHINGTON — The terrorist attacks have presented the Federal Reserve with a new worry. Is it possible that no matter how low the Fed pushes interest rates, it won’t overcome the forces threatening to push the country into a deep recession?

"The Fed has to be concerned about running out of ammunition," Sung Won Sohn, chief economist at Wells Fargo in Minneapolis, said Thursday.

The rate cuts the Federal Reserve announced on Tuesday marked the ninth time this year it has lowered interest rates. The central bank pushed its target for the federal funds rate, the interest that banks charge each other, down to 2 percent, a level not seen since May 1962.

While analysts believe the Fed will keep cutting as long as economic conditions worsen, they wonder how much that will boost borrowing, given that rates are already so low.

Some economists have begun to express fears that the United States could be headed the same way as Japan. The world’s second-largest economy has suffered through a decade-long bout of economic malaise despite substantial interest rate cuts by the Bank of Japan. One key rate the bank controls is now essentially at zero.

"Japan’s troubles show that the usual defenses against economic slowdown can fail," Princeton economist Paul Krugman wrote in an article in Sunday’s New York Times.

Krugman warned that the United States could fall into its own "liquidity trap," in which no matter how low interest rates fall, consumers and businesses remain unwilling to borrow because of their fears about the future.

Those worries have grown because of a plunge in consumer confidence since the Sept. 11 attacks.

Thousands of layoffs in the airline and travel industries have arrived at a time when the jobless rate was already rising because of a yearlong economic slowdown.

The unemployment rate in August was 4.9 percent, 0.4 percentage-point above the July level, and analysts believe the September rate, to be announced Friday, will rise to 5 percent. The rate by October could be 5.3 percent or higher, they say.

"This is about as bad as it gets," said Mark Zandi, chief economist at Economy.com. He said new layoffs could total a half-million in the next few months.

The more optimistic economic analysts, including officials in the Bush administration, believe the Federal Reserve magic of low interest rates will work again to stimulate higher demand.

They contend that Japan’s economic problems have been exacerbated by a huge overhang of bad loans being carried by Japanese banks, in contrast to the healthy balance sheets of American banks.

The optimists believe that any recession in the United States will be over by early next year as the Fed credit easing and the $40 billion in tax rebate checks in the mail before the terrorist attacks combine with more than $100 billion expected in new government spending and tax relief in the wake of the attacks.

"Eventually, the Fed’s rate cuts will work. The problem is that monetary policy takes time. That is why adding in some more help from a new fiscal stimulus package is a good idea," said David Wyss, chief economist at Standard &Poor’s Co. in New York.