When the stock market fell out of bed and the economy teetered last year, the Federal Reserve and Bush Administration knew exactly what to do. Fed Chairman Alan Greenspan slashed interest rates 11 times in the central bank's fastest rate-cutting spree ever. George W. Bush was no slouch, either. The President rammed through a $1.3 trillion tax cut that included a quick $30 billion rebate to aid struggling families.
All that, however, feels like a long time ago. The stock market is once again tumbling, and the recovery is at risk. But this time, the challenge is different and, in some ways, more daunting. On one level, the real economy is on the upswing, as evidenced by a healthy 0.8% rise in industrial output, reported on July 16. Yet investor psychology has turned pessimistic, fed by accounting scams and fears that many companies' profits will have to be revised downward.
As a result, there is a growing sense that traditional stimulative measures may not work in the face of investor panic. Instead, what economic policymakers need to do is somehow convince investors through words and deeds that they are up to the task of tackling corporate crime. But as Bush's ham-handed attempts to manage the market in recent weeks clearly show, that's a lot easier said than done.
Much is at stake. The White House reckons that the 13% drop in the market since May could reduce economic growth by as much as 0.7 percentage points over the course of a year. And some Bush Administration officials, most notably perennial economic bear and chief economic adviser Lawrence B. Lindsey, fret that further falls on Wall Street are in store. Swooning stocks hurt the economy by robbing consumers of spending power and making business investment more costly. Politically, they also pose dangers for Bush. While his overall approval ratings remain high, he has slipped behind Democrats in the polls on the issue of who is best able to clean up corporate corruption.
Small wonder, then, that it's nail-biting time at the White House and the Fed. Part of the unease has to do with the feeling that the tried and true solutions to economic angst may not work this time. Greenspan signaled on July 16 that he was in no mood to cut rates again to bail out the stock market. With short-term rates already at a 40-year low of 1 3/4%, the Fed has to be careful to husband what monetary ammo it has left. What's more, a rate cut now might do more harm than good. It would pump up an inflated housing market some Bush officials fear is already a bubble. It might also dent the dollar, whose weakness is starting to worry the Fed.
Fiscal policy, too, seems to be in a lock. Some in the Administration would no doubt like to accelerate the personal income tax cuts now slated for 2004. But politically, that's not feasible. Democrats are already attacking Bush over the $165 billion budget shortfall projected for this year. And there's a danger that overly aggressive fiscal action may spook the bond market by heightening concerns of big budget deficits.
So are policymakers powerless? Far from it. But they may have to think unconventionally to convince investors that the markets finally are on the mend. Greenspan made a start on July 16. In a rare admission of error, the Fed chief acknowledged being mistaken in thinking that accountants could regulate themselves. And he strongly backed a Senate bill to reform their industry--to the dismay of White House economists who favor a milder House version. In another blow to Bush, Greenspan repeated his strong support for deducting stock options as an expense on corporate income statements.
So far, Bush has been much less reassuring. In two speeches punctuated by market swoons, the President seemed an unconvincing reformer. He can do better. But he needs to clear the air of lingering doubts about his share dealings as a director of Harken Energy Corp. (HEC
) more than a decade ago. He also must show he's willing to take on the Big Business donors who bankrolled his Presidential campaign. That means signing on to the drive to expense stock options and working with Congress on a tough accounting bill.
Of course, restoring investors' faith in financial markets isn't going to happen quickly. "Confidence is a difficult thing to put your finger on," Greenspan said. "You don't reverse investor...confidence overnight." True enough. But recognizing the dimensions of the problem and responding with a convincing plan would be a good place to start.
Miller covers the economy from Washington, D.C.
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