Three prominent economists are urging the Federal Reserve to cut interest rates again.

At a House Budget Committee hearing Friday, Benjamin Friedman of Harvard University, Allen Sinai of the Boston Co., and Donald H. Straszheim of Merrill Lynch & Co. said the federal funds rate should go down.

While they lauded the Fed for earlier, though cautious, cuts in interest rates, the economists said those moves have been largely ineffective in spawning economic growth.

"The Federal Reserve is facing a hurricane,

V not just the head wind that Chairman [Alan] Greenspan has described," said Mr. Sinai, chief economist of the Boston Co., which is owned by American Express Co.'s Shearson Lehman Brothers. "With so many structural impediments to growth, the stimulative effects of easier money on the economy have been overwhelmed."

Mr. Sinai said a quick, sharp reduction in the fed funds rate, currently targeted at 3%, is necessary to reach a 2.5% annual rate of real economic growth.

Inflation Called No Danger

"A re-ignition of inflation would not occur even if the federal funds and discount rates were lowered by another percentage point," he said. "Instead, economic growth and demand would more likely be restored."

The economists said they recognized that the Fed may be reluctant to cut rates again, since such a move would be likely to depress the dollar in international currency markets. But the "continuing stagnation gripping our economy," as Mr. Friedman put it, should outweigh this fear.

"The inflationary consequence of a weak dollar is a small item when the inflation rate is low, as is the present case," Mr. Straszheim said.

Reliance Urged on Market

"More desirable than the current policy of settling the federal

V funds rate at levels not those of the market would be a freeing up of interest rates to whatever levels the demand and supply of funds would bring," he said.

This could be achieved, Mr. Straszheim said, by targeting bank-reserve growth, a strategy similar to that used by Fed Chairman Paul Volcker in the early 1980s.

Mr. Sinai predicted that the federal budget deficit would reach $360.2 billion in 1993 and that the country would see "sluggish, although better, economic growth" in the next two years. A bona fide recovery is likely in early 1993, he said.

While the economists suggested that economic conditions would improve in coming months, this recovery will be vastly different than previous ones, they said. Banks likely will play a much more limited role in stimulating investment than they have in the past, the three suggested.

"Nearly every major category of lender in the U.S. credit markets has suffered at least some deterioration in its ability to provide credit to those firms in nonfinancial lines of business that are still willing to invest," Mr. Friedman said.

"The United States economy in the 1990s must rely on nonfinancial business that are less able to finance new investment internally and a credit system that is less prepared to provide external financing," he added.

More Consolidation Foreseen

And Mr. Straszheim warned that banking industry consolidation has only just begun and will likely continue well into the next decade. He likened today's overbanked economy to the glut of service stations in the early 1970s before gasoline prices sky-rocketed.

"There use to be gas stations on every street corner," he said. "Now, there are three banks and an S&L. The question arises: |What do we need all these banks for.?"

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.