Will the Fed's Rate Cut Be Enough?

Federal Reserve is widely expected to cut its key federal funds rate for the ninth time this year, bringing it to the lowest level in nearly four decades, when it meets on Tuesday.

The real question is whether Fed rate cuts, which normally provide a powerful boost to consumer spending, will be enough to win over a nation still under shock and gripped by fears of further terrorist attacks.

Both of the major readings of consumer sentiment — done by the Conference Board in New York and the University of Michigan — show that confidence has been badly jolted by the Sept. 11 attacks.

The Conference Board reading fell by 14.4 percent in September, taking the largest one-month tumble since October 1990, when the United States was preparing to go to war against Iraq following its invasion of Kuwait.

The University of Michigan index of consumers' expectations about the future fell to 73.5, a plunge of 13.7 percent from the August reading. The only two previous times that this index has fallen by similar amounts was the 1990 period leading up to the Gulf War and the 1973 Arab oil embargo.

Living With Fear

Richard Curtin, director of the Michigan survey, said differences are significant between the short and successful Gulf War, after which consumer sentiment rebounded sharply, and the current, perhaps lengthy fight against an elusive foe.

"Fear is the new element for the U.S. economy. ... This apprehension about domestic security and fearfulness of travel in general,'' he told reporters Monday.

Before Sept. 11, the Fed had cut interest rates seven times in its most aggressive credit easing in nearly two decades as it tried to keep the economy out of a full-blown recession.

Most analysts had believed this campaign would succeed with the economy, which slowed to a barely discernible 0.3 percent growth rate from April through June, posting a solid rebound in the second half of this year.

But now with the extensive economic damage from the Sept. 11 attacks — from rising layoffs in the airline and tourist industries to rising consumer unease — many analysts believe the country is now in a recession which will probably last until the spring of next year.

Another Cut in November?

David Wyss, chief economist at Standard & Poor's in New York, said he looked for the Fed to cut its target for the federal funds rate, the interest that banks charge on overnight loans, by a half-point to 2.5 percent on Tuesday, the lowest level for this key interest rate since 1962. Wyss predicted another quarter point reduction at the Fed's next meeting in November with further cuts possible.

While all this credit easing should be enough to revive the economy in the early part of 2002, Wyss said there is an unusual amount of uncertainty surrounding the economy at present.

"A lot will depend on how the war will play out and whether there will be more terrorist attacks,'' Wyss said. "We just don't know.''

Treasury Secretary Paul O'Neill now believes that the gross domestic product — the total output of goods and services — could drop into negative territory in the just-completed July-September quarter.

But he still believes that growth can resume in the fourth quarter, "if we take the appropriate policy steps,'' Treasury spokeswoman Michele Davis said on Monday. The administration is preparing a new economic stimulus package that will include extra spending and tax relief for individuals and businesses to fight off a recession.

Even if the country does suffer a recession - traditionally defined as two consecutive quarters of falling GDP, most analysts are looking for a rebound at least by the second half of next year, fueled by the Fed rate cuts, tax reductions and increased government spending.

"Given all that stimulus, it's hard to see how the economy won't respond strongly,'' said Bruce Steinberg, chief economist at Merrill Lynch. He forecast the GDP would shrink at an annual rate of 1 percent in both the third and fourth quarters of this year but will resume growth of 2.2 percent in the first quarter of next year.

Because of their expectation of a rather mild recession, analysts believe the unemployment rate will top out at around 6 percent. It has already risen from a three-decade low of 3.9 percent to 4.9 percent in August.

The Associated Press contributed to this report.