Alan Greenspan, the Federal Reserve chairman, has said for months that the biggest weakness in the economy is anxiety about "geopolitical risks" -- namely the threat of war in Iraq. Once that is "resolved," he has said, confidence should rebound and growth should resume to more normal levels.
But as the Iraq debate has dragged on longer than expected and the economic news has become worse, Greenspan is coming under increased pressure to reduce interest rates when the Fed's monetary policy committee meets on Tuesday.
The drumbeat of bad news -- the economy lost 308,000 jobs in February, retail sales slumped more than expected and oil prices surged to nearly US$40 a barrel before easing back -- has heightened fears that the economy is suffering from more than just war jitters and has increased speculation among investors that the Fed may lower interest rates.
PHOTO: NY TIMES
Most analysts say the Fed is much more likely to stand firm on Tuesday. Rather, they say, the central bank is likely to warn that the risks of a slowdown have increased and that it will "closely monitor" events.
That would be a signal of its readiness to pump money into the economy quickly, without waiting until the next scheduled meeting of the Federal Open Market Committee, if a potential war with Iraq went worse than expected or if confidence failed to bounce back afterward.
"I don't think there is much chance of a rate cut next week," said Diane Swonk, chief economist at Bank One in Chicago. "Greenspan has been pretty clear that he thinks Iraq is the major disturbance in the economy."
Thus far, neither Greenspan nor any other top Fed official has hinted at a willingness to cut rates immediately. Indeed, Greenspan went so far as to say at a congressional hearing last month that he saw no need for stimulating the economy through special tax cuts like those proposed by President Bush.
But if Greenspan does not push for lower interest rates on Tuesday, economists say, it will probably not be long before he does, perhaps before the next policy-setting meeting in May.
"If it were not for the background of war uncertainty, the fundamental data would be pointing unambiguously to an aggressive move," said Robert V. DiClemente, chief US economist at Salomon Smith Barney, who is among economists who have become noticeably more pessimistic in the last few weeks.
"All of us have edged our numbers down," he added.
Richard B. Berner, an economist at Morgan Stanley, said the economy was suffering from more than just the paralysis caused by war anxiety.
"The big story is the energy situation," he said. Higher oil prices stem not only from concerns about the loss of Iraqi crude oil, Berner said, but also from drop-off in production from Venezuela after a national strike, low inventories in the US and limited additional production in the major oil-producing countries.
Greenspan has long paid close attention to oil prices, and Fed officials are well aware that big surges in oil prices have been followed by recessions in the 1970s, 1980s and after the Persian Gulf War in 1991.
But some Fed officials have suggested that the current jump in oil prices may be less threatening than it seems. Ben S. Bernanke, a Fed governor, contended in a speech last month that previous recessions were driven less by high oil prices than by the Fed's reaction to them.
"My reading of the evidence suggests that the role the conventional wisdom has attributed to oil price increases in the stagflation of the 1970s has been overstated," Bernanke said. The real problems, he said, stemmed from deeply rooted inflationary expectations at the time and the Fed's decision to tighten monetary policy in response to the surge in oil prices.
Today, analysts say the Fed has much more latitude -- and the markets know it. Inflation expectations are so low right now, sometimes bordering on worries about deflation, that most economists believe the Fed can cut rates without igniting inflationary fears.
"They have a lot of running room," said DiClemente.
At the same time, analysts think Greenspan has good reasons to be cautious. The biggest one is that the federal funds rate on overnight loans between banks is already at 1.25 percent, and monetary policy moves into uncharted territory if the rate drops to zero.
If the Fed were to lower rates next week, it would have less ammunition to stimulate the economy if a war with Iraq turned out to be more costly and protracted than expected. Greenspan has said the Fed can stimulate the economy even if overnight interest drops to zero, by buying Treasury securities. But the Fed has almost no experience with that approach.
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