A Little Pill From Dr. Greenspan

What a difference a few months can make. Back in February, all signs pointed to a short and shallow recession: peace in the Middle East, lower interest rates and oil prices, sharply higher consumer confidence, and a surging stock market.

The celebration was premature. More than two months after the war's end, unemployment claims are still high, factory orders are down for the fifth consecutive month, and private construction spending has dropped every month since July. Consumers may have been ebullient over the quick victory in the gulf, but soaring spirits could not offset the powerful drag of too many pink slips and too much household debt. With a summertime surge no longer a sure bet, the Federal Reserve Board decided on Apr. 30 to take out a bit of recovery insurance. It sliced the discount rate from 6% to 5.5%, the third such cut in four months (chart), and also lowered the federal funds rate by a quarter of a percentage point, to 5.75%. Many banks cut the prime rate to 8.5% from 9% the next day, and other lending rates should follow the prime's downward track.

The Fed eased after a weekend of high-pressure politics. Both the White House and the Treasury lobbied hard for a global cut in interest rates at a meeting of the finance ministers and central bankers from seven major industrialized nations, the so-called G-7. At a breakfast on Apr. 28, President Bush himself pressed the case, to no avail.

'ON TRACK.' With or without the approval of his European and Japanese peers, however, Fed Chairman Alan Greenspan acted. Most board members and regional bank presidents at the Fed now discern a recovery waiting in the wings and believe that more interest rate cuts won't be needed. As one senior official puts it: "We're on track for an upturn by the middle of the summer." Some private economists and business executives aren't quite so confident. But there's widespread agreement that the Fed has taken a step in the right direction. "It should help, and the economy desperately needs help," says David N. McCammon, treasurer and finance vice-president at Ford Motor Co. Adds Robert Brusca, economist at Nikko Securities Inc.: "If you want to help the patient, you have to give him a transfusion while he's still alive."

That's a tad hyperbolic: Recessions do end. Nevertheless, whether this rebound starts midsummer or late fall, it might rise much less than the average 6% gain in real gross national product that comes in the first year of recovery. In most business cycles, the turn comes when consumers, spurred by lower rates, start borrowing and spending again. Businesses, already carrying lean-and-mean inventory levels, rev up their production lines. Workers worry less about layoffs and buy more. And so on.

From the start, the 1990-91 recession has been anything but average. Typically, the economy slumps after a sharp rise in inflation forces the Fed to push interest rates higher, cooling off both inflation and the economy. This time, though, inflation was relatively tame and interest rates stable. The economy did indeed edge lower, but it occurred as a stingy monetary policy collided with the financial excesses of the 1980s.

LOST YOUTH. It takes time to repair tattered balance sheets and restore incomes. The bloated service sector faces years of restructuring and cost-cutting. Widespread state and local budget deficits could further depress the upturn. Demographic pressures are another damper: Baby boomers are starting families and changing their free-spending ways. And the younger, less numerous, baby-bust generation by definition demands less of the economy. The net effect of all these economic brakes? "The recovery will be anemic," says Richard Berner, economist at Salomon Brothers Inc.

That's not great, but manufacturers will take it. Orders at Clark Equipment Co., a maker of construction gear, have been in a rut for several months. And Cummins Engine Co. laid off 170 factory workers in April, bringing total layoffs to 3,800, or 14% of the company's work force. "Buyers of capital goods haven't concluded that industrial production will improve," says Chief Financial Officer Peter Hamilton. "We are planning on no economic recovery this year."

Hardest-hit are the auto companies, which traditionally have helped lead the economy out of recession. The Big Three, which lost $1.9 billion in the first quarter, are in no shape to provide a boost to the economy.

Consumers aren't buying cars, or much else. The specter of layoffs still haunts the economy--from factories in Indiana to banks in New York (chart). On May 2, General Dynamics Corp. was set to announce plans to lay off 27,000 workers--30% of its payroll--over the next four years. Such large cuts aren't surprising given the dim growth prospects for defense. Big contractors are simply adjusting to a grim outlook.All this somber news doesn't make for carefree shoppers. The Conference Board's consumer confidence index backed off marginally in April, and, according to Edward Yardeni, chief economist at C. J. Lawrence, the University of Michigan's index of consumer expectations gave back in April about half of March's sharp gain. There is a risk, notes a senior Fed official, that "the consumer confidence burns off before the spending picks up."

That's just what seems to be happening to the California economy. After the war, "there was a psychological bounce, but for the economy, there was no bounce at all," says Jack A. Kyser, chief economist for the Los Angeles Area Chamber of Commerce. The state's defense and aerospace industry is shrinking, its construction industry is in the pits, and agriculture, a $17 billion industry in good years, is suffering from the aftereffects of this winter's freeze, as well as a persistent drought. The state is now struggling to close a record $12.5 billion budget deficit.

BRIGHTER SIGNS. The weakness is spreading to parts of the country assumed to be relatively immune. Take the Southeast. "The region is struggling to absorb a serious construction contraction, declining manufacturing demand, falling revenues, sharply declining profits, and a slowdown in migration of people and capital from other regions," says Donald Ratajczak, director of the Economic Forecasting Center at Georgia State University.

Some breaks in the clouds are starting to appear, however. Among the most encouraging signs: the recent upturn in new and existing home sales. Personal income eked out a gain in March. The index of leading economic indicators has risen two months in a row. Better yet, the Fed's latest rate cut will bring the recession to an end sooner rather than later. That's because the economy is no different from the rest of us: the more money, the merrier.

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