Time for the Fed to Cut Interest Rates

James K. Glassman | August 25, 1998

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Prince and Gardner see the U.S. economy as precarious. "Inventories are high, and growing too rapidly," they say. Industrial production is slowing. Meanwhile, commodity prices are crashing, with oil and gold at the lowest levels in a decade. Deflation, not inflation, is the threat.

Can't the Fed change course and cut rates if a slowdown becomes more evident? Maybe not. Wesbury quotes economist Joseph Schumpeter, writing in 1931: "It is easier to dampen prosperity by a high rate of interest than to alleviate depression by a low one." The Japanese have recently learned how right Schumpeter was.

So why does the Fed insist on high rates? We can't tell for sure, but Greenspan is clearly concerned about an overheated stock market. If rates are cut, the thinking goes, then stocks will soar -- as they usually do when borrowing costs fall.

"We're in this ridiculous situation where the Fed is waiting for the stock market to go down before they can ease," says economist John Makin, my colleague at the American Enterprise Institute. Makin, who has been warning for a year of the dire deflationary effects of the Asian crisis, wants the Fed to cut rates now.

"Things are pretty ugly," he says. Much of Asia is in a depression. The Russians went through $23 billion in IMF dough in just weeks. Latin America is suffering. And lower consumer demand globally is hurting U.S. corporate profits.

A rate cut would help the world, not just the United States, say Prince and Gardner: "Nothing would do more to address the plight of emerging markets and Asia than a Fed easing."

The Fed, however, continues to be hung up on a stock market it believes to be overvalued. "Amazingly," says Yardeni, "the Fed is biased toward raising interest rates." However, he says, "with events coming unglued so rapidly, a cut in rates is conceivable by year-end."

But will that be too late?