One question uppermost in the minds of political and business leaders the world over probably is whether the slowing U.S. economy will pick up in the second half of this year. The Federal Reserve Board on Wednesday provided its answer by cutting key interest rates for the fourth time since January. The Fed has demonstrated its determination to halt the slide, sending a clear signal that it is looking for a second-half recovery.
It usually takes about half a year before a monetary-policy move shows its effect. In this sense, Fed Chairman Alan Greenspan has made a timely move, looking to domestic economic developments about six months ahead. The rate cuts are also expected to have salutary effects on Japan’s faltering economy and other economies around the world, including those in Asia and Europe.
The U.S. economy has slowed sharply since last autumn, as evidenced by stock-price falls and the collapse of the “Internet bubble.” The Fed has moved quickly and boldly. In just four months since January, it has slashed the federal funds rate — a sensitive barometer of short-term interests — and the official discount rate by as much as 2 percent each to 4.5 percent and 4 percent respectively.
The administration of President George W. Bush, which took office at a time when the longest economic boom in U.S. history was over, faces the onerous task of stemming a recession and initiating a recovery. Failure to do so would make the administration vulnerable to criticism that it had made economic-policy mistakes or neglected to take recovery steps.
Mr. Bush’s commitment to a $1.6-trillion, 10-year tax cut is proof that he is determined to put the economy back on a solid recovery path and leave his name in history as the creator of a new U.S. boom. It is difficult not to think that Mr. Greenspan, who has guided U.S. monetary policy since the Clinton era, is unaware of Mr. Bush’s intentions.
The Fed’s latest move, however, has come as a surprise to market players. Mr. Greenspan has said time and again that he will not change interest rates simply because stock prices have gone up or down or because the market wants him to change the rates. In fact, following each of the previous three cuts, the Fed ignored calls from economists and analysts for further reductions.
Recently, the U.S. economy showed signs it might have hit bottom. For instance, the stock market stopped falling and the industrial-production index for March rebounded for the first time in six months. Mr. Greenspan surprised market participants who had ruled out immediate rate cuts in view of those signs of improvement. The unexpected move has helped to boost market psychology. The day the move was announced, the Dow-Jones industrial average went up nearly 400 points while the Nasdaq composite index climbed back above 2,000 points. In response, share prices rose in Tokyo and elsewhere.
However, it is hard to tell how the U.S. economy will develop in the months ahead. True, business inventories are reaching more manageable proportions while personal spending and residential investment are holding up. But capital investment is sluggish and corporate earnings are declining. The stock market remains basically weak, despite recent rebounds.
A V-shaped recovery — a sharp slowdown in the first half, to be followed quickly by an equally sharp recovery in the second half — now seems unlikely. More likely would be a U-shaped recovery following a period of little or no growth or, worse, an L-shaped pattern whereby recession leads to indefinite stagnation.
However the economy may develop, the United States has an advantage that Japan does not: the fiscal and monetary freedom to stimulate growth. The Fed can cut interest rates further if necessary, while the administration can boost domestic demand through major tax cuts. Moreover, as the world’s largest economy, the U.S. can — and indeed should — resume its role as the engine for global growth.
By raising interest rates another notch, the Fed seems to be trying to send a reassuring message: It expects the U.S. economy to begin recovering in the second half and that further easy-credit measures, including additional interest-rate cuts, may be taken to ensure that the economy gets back on track before long. Mr. Greenspan probably will find himself in a strong position at the forthcoming meeting of G7 finance ministers and central-bank governors.
For Japan, the only way out is to continue steady efforts to achieve a sustainable recovery, with priority given to bad-debt disposal and structural reform. It should resist the temptation to try to revive growth on the back of a U.S. recovery.
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