Commentary > HaysWire
Fed vet: "extraordinary pessimism"
Former Governor Meyer sees rebound but worries about spending; expects Fed to stand pat.
January 29, 2003: 4:24 PM EST
By Kathleen Hays, CNN/Money Contributing Columnist

NEW YORK (CNN/Money) - Don't look for the Federal Reserve to make any changes -- no rate cut, no change in policy stance -- but keep your fingers crossed that this is the right decision: that's the message from a conversation with Laurence Meyer, former Fed governor and a noted economist in his own right.

Larry left the Fed in January 2002 after more than five years on the Board of Governors. He's widely credited with leading the charge for higher interest rates when the economy was booming during the stock market bubble of the late 90's. He's also a very personable, engaging guy who loves to teach.

Right now he doesn't think the Fed needs to do anything more on rates because he believes the economy is on track to gradually pick up steam over the course of the year. "The fundamentals are sound enough that the economy can put most of its imbalances behind it, and lifting the geopolitical risk in some way will allow the economy to rebound."

The risk in the forecast? "There's just this extraordinary pessimism right now that creates a lot of uncertainty."

In fact, he says it looks like fourth quarter growth was flat to slightly negative (we'll know for sure on Thursday when the government releases the numbers on Gross Domestic Product, or GDP, for the final three months of the year). "Employment is grim, profits are not good, there's no sign of a rebound in capital spending, and there's some concern about continued strength in consumer spending."

This is why Larry is still worried and why he thinks policymakers at the Fed are worried too: there's "tension between the data and the forecast." In other words, he thinks things are going to get better, but so far the economic reports don't completely support that view.

I asked him if there is still a risk of deflation in the U.S. economy -- that's the dreaded downward price spiral that worms its way into all sectors, from manufacturing to services, and causes profits to fall (really tough to grow profits if prices are falling) and leads to more layoffs, more bankruptcies, and falling stock prices.

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Larry said no, unless we have a recession, no deflation -- BUT -- he said there are some downward price pressures that need to be watched like a lot of excess capacity in manufacturing, and massive cost-cutting. Deflation "doesn't look imminent but it can't be easily brushed aside given the failure of the economy to get to above-trend growth."

So, given all this, are Alan Greenspan and the folks at the Fed going to do ANYTHING to make sure we don't get to that awful point? Small rate cut? Maybe even a shift in their closely-watched policy bias?

According to Larry, No.

He believes the Fed will respond to bad news on the economy if that's what we see in the coming weeks, but for now officials are optimistic the recovery will keep gathering steam. The Fed's view: interest rates are low, the economy's fundamentals are sound as evidenced in its ability to withstand shocks (like 9/11) and to get through a mild recession. So no rate cut.

As for a change in the policy stance, first, some context. In November the Fed said it was shifting that bias, away from being worried about the economy (which the markets take as a signal the Fed is prepared to cut rates if need be) back to a neutral stance where the risk of recession and inflation are given equal weight. This surprised a lot of economists who thought at the time there was no way the Fed could say the risk of inflation was anywhere near the risk of recession, but that's what they did.

"The story is not where you are now, but if you want to convey a change," Larry says. To change the bias back to "worry about the economy" would create an expectation the Fed is ready to cut rates when it may not be, and would make the markets overly sensitive to incoming economic data.

-- Hays will interview Meyer on CNNfn's Money and Markets at 5 p.m. ET  Top of page

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