The Economy -- No One-Trick Pony

That Alan Greenspan sure is a bunch of laughs, isn't he? He always seems to have another trick up his sleeve. After the Fed's very own March index of industrial production showed an unexpected 0.4% gain, the cognoscenti of the Fed forecasting racket were virtually unanimous in proclaiming there would be no rate cut before the next Federal Open Market Committee meeting. But Greenspan snookered 'em again. The creed of the crafty boxer: Hit when they aren't looking. So the market responded in spades to the 0.5% cut on Apr. 18, although a few cynics pointed out the same thing happened on Jan. 3, only to see the market give back all its gains and then some in February and March. In one sense the Fed is the quintessential lagging indicator. The economy had clearly slowed down by the second quarter of 2000; even the stock market reflected that. Yet Greenspan continued to push for higher rates, boosting the funds rate to 6.5% in late May and failing to start easing until early this year. The initial moves to ease thus started two to three quarters too late. By the same token, and based on previous experience, it is reasonable to assume the Fed will continue to ease well into the recovery period. Since the economy started to rebound last quarter, further Fed easing as late as the third quarter remains a distinct possibility. How much further can the Fed cut the funds rate? One argument against further rate cuts is that longer-term interest rates have already started to move higher; in 1992 long-term rates fell steadily all year along with short-term rates, and in fact even continued to decline through October 1993. If the Fed uses the bond market as a reality check, that would argue against further rate cuts. However, rates in 1992 already had started to move up. Recently, real growth fell to 1% to 1.5% at its trough. Interest rates recently have fallen about 2%, which will boost growth by 2% later this year, and the improvement in the stock market will add another 0.5%. Lower petroleum and natural gas prices also will add about 0.5%. Finally, the tax cut should add 0.5% to 1% to the growth rate later this year. Taken together, these factors should boost real growth by 3.5% to 4%, raising it to 5% to 5.5% by late 2001 and early 2002. If the Fed continues to cut aggressively, that might boost my forecast -- already the highest around at 5.1% -- to 5.5% in 2002. Yet the issue keeps surfacing that in spite of massive Fed rate reduction in 1990-92, the economy sputtered; after emerging from the recession real GDP rose at an annual rate of only 1.7% in the remaining three quarters of the year, and then advanced at only a 2.8% annual rate for the next seven quarters before finally catching on fire in the fourth quarter of 1993. That was caused by the decline in bond rates due to the abrupt reversal of the Clinton Administration fiscal policy, convincing investors that the deficit would indeed be reduced. However, the differences between the current situation and 10 years ago are far greater than the similarities. To see this, compare the growth in business loans and commercial credit in real terms in the 1990-92 era with what is happening now and projected for the near future. Back then, credit and loans fell at annual rates of about 6%; now they are rising at about a 6% rate. The decline was a direct result of the fallout from the S&L crisis. That, and not the level of interest rates, was the main reason the economy failed to recover. Another key difference is the behavior of the personal-saving rate, which rose during the 1990-91 recession and kept rising during the early stages of that recovery. The rate has continued to decline in recent quarters in spite of the stock market plunge. While it is possible that the personal-saving rate suddenly will recover in the next few quarters, I find it especially significant that it continued to fall even after stock prices declined so rapidly. As a result, the economy already is on the road to recovery, and further Fed cuts will simply speed the turnaround. I look for real growth to return to above-average rates and remain there shortly after midyear. Michael K. Evans is president of the Evans Group, an economics consulting firm in Boca Raton, Fla.