Fed, Banks Cut Rates; Effect Called Negligible
Despite reductions in the discount rate and prime rate on Friday, economists expressed doubts that the economy would be invigorated any time soon.
In a long-expected move, the Federal Reserve cut its discount rate Friday by a half point, to 5%, leading major banks to cut their prime rates to 8% from 8.5%.
The discount rate now stands at its lowest level since 1973 and the prime rate at its lowest point since 1987.
Debt Levels High
In playing down the likely impact of the rate cuts, economists pointed out that consumers, businesses, and governments are all burdened by record levels of debt. Thus, their interest in further borrowing is likely to be limited. Without new borrowing, spending will not accelerate and the economy will stay weak.
"I'm hopeful the move will keep us out of recession, but I doubt it will prompt any significant improvement," said Ward McCarthy, a managing director at Stone & McCarthy Research Associates. "This recovery is anemic and it's going to stay that way."
Fed Funds and Prime Are Cut
The discount rate move was followed within hours by a cut in the target fed funds rate to 5.25% from 5.5%, a further indication of the central bank's desire to stimulate economic activity.
By Friday afternoon, Morgan Guaranty Trust, Citibank, Chemical Bank, First Interstate, Bankers Trust, and Chase Manhattan had cut their base lending rates by 50 basis points. Other banks were expected to follow.
But the reduced prime is no guarantee of increased loan demand, since banks account only for 18% of all lending activity, said Raymond Dalio, president of Bridgewater Associates, a money management firm.
Skepticism on Impact
"I don't think you're going to see a pickup in loan activity," Mr. Dalio said.
Nor do lower interest rates automatically reduce the massive amounts of debt already outstanding. In spite of some recent declines, consumer installment credit reached a whopping $733.6 billion in April 1991, up from $622.1 billion just three years earlier.
In addition, the federal government's deficit is at record levels, and hundreds of companies spent the 1980s leveraging up their balance sheets.
Little Expansion Seen
The rate cut "is a welcome move and a positive move, but other things have to happen," said a regional banker in the Northeast. "There aren't many people I see in my travels who want to expand their businesses. They're hunkering down."
Treasury bond prices moved up in advance of the long-awaited rate cuts.
The benchmark 30-year Treasury bond had been trading below 8% for several days prior to the announcements.
The price rose as high as 102.26 to yield 7.87% early Friday morning, when the Commerce Department released retail sales and consumer price data suggested continued weakness in the economy.
But the price actually fell after the discount rate cut was announced, and 30-year Treasuries were trading at 101.29 to yield 7.95% Friday afternoon.
"This discount rate cut was thoroughly anticipated by the time it was announced," and traders responded by taking profits, said Charles Lieberman, director of financial-markets research at Manufacturers Hanover Corp.
Similarly, the stock market fell following the discount rate cut. The Dow was down 24.38, to 2983.45, Friday afternoon.
In recent years, the discount rate has often remained stable for months, but Friday's move was the fourth in 1991. Some economists think the weakness in the economy is so entrenched that the Fed may even cut the rate a fifth time before the year is out.
"Things have stopped getting worse, but it's not clear that they're getting better," Mr. McCarthy said. "I think you'll see them ease before the end of the year."