Effect of Fed's rate cut may not show up for months

The Federal Reserve jolted the U.S. economy Tuesday with the largest single interest-rate cut in two decades, conceding by its move that six months of more-modest action had done little to stabilize the world's financial markets.

The bold step, a cut of 0.75 percentage point that one Fed watcher called "emergency room-style" central banking, is a dramatic departure from Fed chief Ben Bernanke's deliberate style, and would seem to signal an end to debate within the central bank about whether the economy faces a more imminent threat from recession or inflation.

Few economists are certain that a prolonged slump can be averted. But they agree on one point: Recession or not, the economy in the year ahead will be uninspiring.

"The best thing about 2008 is that it's going to be over in 12 months," said Kenneth Goldstein, senior economist at the Conference Board, a business research group in New York City.

Plummeting financial markets in Asia, and a similar performance from the U.S. markets, apparently pushed the Fed to act a week ahead of its planned meeting.

Fed watcher Bill Melton said if the Standard & Poor's 500 had fallen in tandem with overseas markets, the key index would have lost 6 percent of its value Tuesday. Instead, the S&P index fell 1.11 percent. After losing 460 points in early trading, the Dow Jones industrial average regained much of the lost ground and closed down 128.11, or 1.06 percent.

"It's easy to see why they decided to buy some insurance," Melton said of Fed officials. "If you believe, as most economists do, that the wealth effect is a major component of business activity then [you want to avoid] lopping off another 5 percent of equity value," said Melton, president of Melton Research in Edina.

"The Fed is responding to an economy and financial system going into cardiac arrest," wrote Scott Anderson, senior economist at Wells Fargo & Co. in Minneapolis. "This will require emergency room-style policy action from the Fed."

Goldstein said the Fed's move was "tamping down the panic" in financial markets in a step that was more dramatic than what economic fundamentals would have required.

"This had more to do with Wall Street than Main Street," he said.

Others criticized the Fed for waiting so long to pare interest rates substantially.

"The Fed realized it was too far behind the curve," said David Wyss, chief economist at Standard & Poor's in New York. "This was an attempt to catch up."

Economy should benefit

Forecasters said the economy should benefit from an interest rate cut.

"The evidence of the economy in a recession is mounting," said Nariman Behravesh, chief economist at the economic consulting firm Global Insight in Boston. "It's a very safe bet that the first quarter will be a negative."

The problem with the Fed paring short-term interest rates is that the move could take months, even years to ripple through the economy, lowering the cost of borrowing on everything from cars to construction.

The first effects of the stimulus won't be measurable until summer, if not next year.

Lower interest rates and proposed tax rebates by Congress do "hold the potential to keep the economy out of a recession," said Gus Faucher, director of macroeconomics at the website Economy.com.

"But we won't be sure for three, six months from now," he said. "It will take time for this to sink in. We won't know the answer for a while."

Others say the Fed isn't done.

"Is this enough? No," Behravesh said.

Global Insight expects the Fed to cut short-term interest rates another full percentage point by the end of April, which would put them at 2.5 percent. Former Fed Chairman Alan Greenspan took short rates to 1 percent for a time early in this decade in an effort to get the economy going after the technology stocks crash and the shock of 9/11.

"The risk is, as they do the Christmas-tree routine ... it gets delayed and does no good," Behravesh said, referring to attempts to lard the package with special-interest favors.

Economists can't agree on what remedies are needed, in part, because they don't know how sick the economy is.

While many started saying the economy was in a recession in December, Goldstein said the Conference Board's "coincident indicator" showed the economy was growing at the end of last year.

"The fact is, the U.S. economy was not in a recession," he said. "Despite that, everybody and his uncle is saying we're already in a recession." Goldstein is part of the faction that believes an economic downturn is less likely than slow growth in the months ahead.

Psychology may have more to do with the outlook than economics, he said.