The Split Fed May Keep Rates Right Where They Are

When Alan Greenspan goes to Capitol Hill on Nov. 19, he'll be greeted with praise for his latest moves to boost the economy. In just a week, the Federal Reserve chairman trimmed the key money-market interest rate twice and cut the rate the Fed charges on loans to banks by a half-point. Greenspan can count on the lowest short-term rates in 18 years to soften up the Senate Banking Committee as it sits in judgment on his nomination for a second term at the Fed's helm. The chairman can only hope, though, that none of his questioners wants to look too deeply into those rate cuts. To financial markets and politicians, the Fed moves seemed like natural steps to boost an economic recovery that's fizzling. But a significant minority of the Fed's policymakers disagree -- and Greenspan had to work hard to win even grudging approval for easier credit. The struggle inside the central bank means the Fed is likely to stay on the sidelines in the weeks ahead, waiting to see whether its earlier easing will spark the economy.

Markets had been expecting the Fed to cut rates since the Oct. 1 meeting of its Federal Open Market Committee. But that meeting revealed an unusual split among policymakers. Presidents of the Fed's 12 regional banks -- who usually fear inflation more than slow growth -- reported that businesses and consumers were increasingly worried about the recovery. The Fed's Washington-based governors were skeptical. "Some of the folks here were sitting back with their old forecasts and feeling pretty comfortable," says one governor. While the FOMC authorized Greenspan to cut rates, its mood warned him to go slowly.

By month's end, Greenspan was ready to move. But two governors disagreed. John P. LaWare argued that the economy was suffering from a lack of confidence, not money. And Wayne D. Angell feared that further rate cuts would spook inflation-shy bond traders. Rather than force a 3-2 vote, Greenspan enlisted the regional presidents for a telephone conference on Oct. 30. The lengthy debate kept the Fed's New York trading desk on the sidelines as market rates drifted down. Traders read the Fed's passivity as an ambiguous acceptance of a 5% target rate on Fed funds -- loans between banks -- down from 5.25%. The White House jumped in with a statement praising the reduction. "It may not have been a move before," says a Fed official, "but it sure is one now."

POOR TIMING? The debate resumed on Nov. 5, when the FOMC met again. Officials say the panel ordered Greenspan to cut rates once more. Bowing to the consensus, LaWare agreed to lower the Fed's discount rate; Angell dissented.

Now, it's looking as if that cut may be the last for some time. Many traders criticized the Fed for the timing of its two latest moves: Cutting the discount rate immediately after the Republican loss in Pennsylvania's special Senate election on Nov. 5 "reinforced the market's perception that Greenspan is awkward and influenced by political pressures," says economist David M. Jones of bond traders Aubrey G. Lanston & Co. And the Nov. 13 report of an unexpected 0.7% rise in October producer prices, even though much of the increase was an aberration (page 25 15 ), panicked the bond market into pushing up long-term rates. That strengthens the hand of Angell and other inflation hawks.

More important, even those officials who backed the recent cuts now want to give them a chance to work. The Fed's moves since summer have been designed to "lean into the 50 mph headwind the economy is fighting," says a top official. But "if we're leaning too far when the wind stops, we'll fall over."

Some economists complain that these pauses have paralyzed the Fed at crucial moments in this and past business cycles. They hope soft Christmas sales and the addition of two new Fed members will break the deadlock. White House aide Lawrence B. Lindsey, a supply-side economist who favors strong growth, would be a sure proponent of easier money, but Senate Democrats have stalled a vote on his nomination. Economist Susan M. Phillips will soon be sworn in, but her views on monetary policy are less certain. If both had been on board in October, First Boston Corp. economist Darwin L. Beck suspects, Greenspan would have had "a 5-2 majority, which is a much better signal for action than 3-2."

Even so, Greenspan is likely to adopt a wait-and-see stance. Before the latest moves, he saw an economy that could go either way -- up into renewed recovery, or down into a second phase of recession. It's too soon to tell whether two quick rate cuts will forestall the double dip -- but they certainly have put the Fed out of action for a while.

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