Commentary: Don't Count on a Rosy Second Half

It's becoming the mantra of the monetary policy set. As the economy has continued to weaken with no bottom in sight, Federal Reserve policymakers have taken to the hustings to hammer home the message: Relief is "in the pipeline." After the Fed's five hefty half-percentage-point interest rate cuts, there's considerable monetary stimulus already in the works, ready to give the staggering economy a boost in the second half of the year. Couple that with coming tax rebates, and there's reason to believe the economy has weathered the worst and is ready to rebound.

Trouble is, the economy right now is close to lifeless, with growth in the second quarter probably at or near 0%. If monetary and fiscal policy don't deliver their much-hoped-for jolt soon, there's a real risk the economy could remain stalled or even slip into a recession.

So far, many private-sector economists are whistling past the graveyard right along with the Fed. They're also looking to rate cuts and tax rebates to boost growth. Forecasters polled by BusinessWeek expect the economy to grow at an annual rate of 2%-to-3% in the second half, vs. less than 1% in the first. "The consensus forecast continues to see a pickup in the latter part of the year," Boston Fed President Cathy E. Minehan said on June 18. "I think there is a good chance this is what will happen."

A chance, yes. But the risk is that the consensus may prove to be as overly optimistic on the economy this time around as it has been for much of the past year. Sure, the Fed and the Bushies have done a lot to try to goose growth. And, if you go by the economic textbooks, that should be enough to resuscitate the economy.

But for a variety of reasons, monetary and fiscal policy may not pack as much punch in combating a New Economy downturn that's being driven by savage corporate cost-cutting and slowed capital spending. Moreover, there's even a risk that a second wave of cutbacks and layoffs by profit-pinched high-tech and other companies could blunt whatever stimulus exists in the pipeline, squelching any nascent recovery.

That's why the Fed's next policy-making meeting on June 26-27 may be the most lively it has had of late. Several policymakers, including Governor Laurence H. Meyer and Richmond Fed President J. Alfred Broaddus, have signaled that they want to scale back the central bank's rate cuts to a quarter point. With plenty of stimulus in the pipeline already, they're worried about rekindling inflation. Others, including Fed Chairman Alan Greenspan, see no inflation threat and may be wary of changing the Fed's modus operandi of half-point rate cuts while the economy remains fragile.

An old economics saw says that monetary policy affects the economy with "long and variable lags" of six months or more. If that's right, then the economy should just now be starting to feel the pop from the Fed's first rate cut way back in January. Thus, the widespread faith that a recovery is in the works.

But like so many other things in the speeded-up New Economy, the lags from monetary policy may be a lot shorter than they used to be. A major reason is that, under Greenspan, the Fed has been much more open about interest rate policy and the factors that drive the central bank's decisions. Such transparency has enabled financial markets to often correctly anticipate what the Fed will do and act preemptively, thus reducing the lag. That means we may already have gotten a lot of the bump we're going to get from rate cuts, and any second-half stimulus could be limited.

That certainly seems to be the case with housing, the most interest-sensitive sector of the economy. Long-term interest rates, including mortgage rates, peaked in May, 2000, and then declined steadily throughout the year as economic growth slowed. But since the start of the year--and the Fed's rate-cutting campaign--they haven't changed much at all, and stand at about 7.1%.

Indeed, thanks to last year's drop in mortgage rates, the housing market has held up well in the face of the slowdown in the rest of the economy. But it's unlikely to get any stronger. "It can't lead us out [of the economic slowdown] if it hasn't gone down," says Robert I. Toll, CEO of Huntingdon Valley (Pa.)-based Toll Brothers Inc., the nation's ninth-largest homebuilder.

The same goes for autos, another interest-sensitive sector. Like housing, car sales have fared better than expected in the face of the abrupt slowdown. But here again, it's unclear how long that can last--or whether there's much upside from here on out.

In the first half of the year, auto makers boosted sales through rebates and other incentives that now average about $3,000 a vehicle, up $500 since last fall. That can't continue, acknowledges General Motors Corp. Group Vice-President William J. Lovejoy, who expects sales to cool off in the second half as rebates drop. In fact, sales should fall about 5% in the second half, says DRI-WEFA analyst Scott M. Fontaine. "Right now the deals are so good that people are out there buying," Lovejoy says. "But as inventories come down, incentives will drop."

REBATE CHECKS. Other aspects of the New Economy have proven immune to the Fed's monetary medicine. Take corporate investment, one of the main drivers of growth in the latter half of the 1990s. Saddled with as much excess capacity as they've had in nearly 20 years, manufacturing companies are slashing capital spending plans, despite the Fed-induced drop in interest rates. New orders for capital goods have collapsed to their lowest level in nearly two years.

Add it all up, and it's hard to see how the Fed's loose monetary policy is going to do much to recharge the economy. So what about the tax cuts? Many mainstream economists are counting on fiscal policy to provide the economy with oomph in the second half. Uncle Sam will begin mailing out $38 billion in rebate checks at the end of July. If taxpayers feel confident and spend that money, the rebate could add as much as 1 1/2 percentage points to gross-domestic-product growth in the fourth quarter. But if taxpayers grow worried because of a new round of corporate layoffs, they may well opt to hang on to the cash, or use it to pay down credit-card debt. In that case, the Fed's mantra--that stimulus is on the way--could prove meaningless. And so, too, could talk of a second-half rebound.

By Rich Miller

With David Welch in Detroit, Stephanie Anderson Forest in Dallas, and bureau reports

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