The Federal Reserve this week may start subtracting some of what it added to short-term interest rates last year.
If so, it will be moving none too soon for the benefit of the economy, according to a former top Fed official and a school of economists who think rates were pushed too high.
The Fed's monetary policymakers are scheduled to convene in Washington on Wednesday and Thursday for their midyear meeting.
"This is the crucial time for ensuring economic growth next year," asserts Preston Martin, who was vice chairman of the Fed's board of governors from 1982 to 1986.
Mr. Martin is sharply critical of the central bank for increasing rates last November and again in February, the last two of seven hikes the Fed deemed necessary to cool the economy and short-circuit inflation.
"It was brilliant monetary policy until November, but since then it has been in error," says Mr. Martin, now the chairman of HomeVest Financial Group, a San Francisco-based financial services firm.
"We're paying the price for that now," he contends. "There could well have been a quasi-soft-landing for the economy, but two mistakes were made."
Mr. Martin is particularly critical of the Fed for allowing banking system reserves to fall in an effort to maintain its 6% target rate for overnight interbank loans, the federal funds rate.
He calls the decline in bank reserves, a key unit of liquidity in the economy, "perilous."
Recent data depict business activity as slowing rapidly. Even Fed Chairman Alan Greenspan recently said economic growth "could be marginally negative" in the current quarter.
"In hindsight, the Fed really did overshoot the mark," says Sung Won Sohn, chief economist with Norwest Corp., Minneapolis. "Now the question is how to control the damage."
He also cites the "dangerous" shrinkage of bank reserves, which he said has been going on at the fastest rate since the 1950s.
The Norwest economist urges Fed officials to cut rates this week and "take out an insurance policy" against the possibility that the current weak business climate will "snowball" into a serious economic downturn.
"How much more bad news do they need to convince themselves that the economy is in trouble, maybe deep trouble?" asks Edward Yardeni, chief economist for C.J. Lawrence/Deutsche Bank Securities.
"The fact that inflation remains so subdued, and that the economy is so weak today, suggests the Fed overreacted last year," he says.
Mr. Yardeni suspects "the current slump isn't simply a short-term, self- correcting inventory correction," but instead reflects profound structural changes under way.
He cites five major trends that drove economic growth in the 1980s:
*The buying binge of Baby Boom yuppies.
*The dramatic increase in defense spending during the final phase of the Cold War.
*The stimulative impact of the growth of the "entitlements" sectors of the economy.
*The popularity of tax-sheltered investments in commercial properties.
*The speculative excess of the Japanese in U.S. real estate markets.
These trends have been reversed and now act as drags on economic growth, he said. They have been replaced to a limited and uncertain extent by the high-technology revolution and greater export opportunities in the aftermath of the Cold War.
It could be "that the new forces of light are not powerful enough to offset the new forces of darkness," Mr. Yardeni said.
He suspects last year's rapid economic growth was an aberration due to a refinancing windfall enjoyed by borrowers after the plunge in rates during the prior two years.
With major structural forces depressing economic growth, Mr. Yardeni thinks the Fed "needs to provide as much monetary stimulus as possible, as soon as it can."
And he thinks the Fed will do so, cutting the federal funds rate by a half point either Thursday, after finishing their meeting, or Friday, after the June employment report is released.
Mr. Sohn thinks so also, believing Mr. Greenspan "desperately wants to achieve a soft landing and prevent the economy from skidding into recession" on the eve of a presidential election year. The Fed chairman is also up for reappointment next March.
Mr. Martin, the former governor, says, "I pray that they will make a change in July, but I expect a (rate) change in August."
"There is going to be a major debate at this meeting," he said. "And this is one of the few times I wish I were back there."