NEW YORK -- Weak consumer confidence and purchasing power are preventing the potential benefits of low interest rates from taking hold, asserts economist Andrew F. Brimmer.
"The prevailing logic says that a reduction in interest rates is supposed to stimulate economic activity," he says. In fact, the Federal Reserve followed this recipe with success in the eight business cycles between 1948 and 1982.
But in the current cycle, "while interest rates do play an important role, they are not the dominant factor in determining the level and pace of economic expansion," argues Mr. Brimmer in this week's issue of S&P Creditweek, a publication of Standard & Poor's Corp.
Many Factors at Work
He notes that there is "a complex web of factors" influencing aggregate demand. Among these are consumer spending, business investment, and construction, which together make up more than 85% of gross domestic product.
Mr. Brimmer, president of Brimmer & Co., Washington, and a former Federal Reserve governor, writes that the, "separate contribution of interest rates can be swamped by other developments." Of these, he says, stagnation in employment and personal income are most critical, adding that this "is exactly what happened over the last one and a half years."
The Fed's stimulative monetary policy since the third quarter of 1990 has met with a "subdued" response, as low interest rates failed to significantly boost major components of gross domestic product.
Little Money to Spend
"The very slow growth in purchasing power explains the more moderate response to interest-rate reductions during the current recovery," Mr. Brimmer writes. "In the five quarters ending in June 1992, real disposable income rose by only 2.4% -- roughly one-half the 4.7% rise during the comparable period in 1981-1982."
Thus, recent reductions in interest rates have been "substantially smothered by rising unemployment and little growth in household purchasing power.
"If this vicious circle of economic stagnation is to be broken, there must be an autonomous increase in disposable income and a strengthening of consumer confidence," he says, which argues for "a significant reduction in federal individual income taxes."