“Here’s a familiar time line: The Federal Reserve reduces short-term interest rates. A recession begins. The Fed keeps cutting. Short-term rates stay low, and long-term rates eventually begin to tumble. The economy recovers,” writes Daniel Altman in Sunday’s New York Times.

“It happened in the early 1990’s. It also sounds a lot like the situation of the last couple of years, though the part about a recovery is, for some experts, debatable this time. Part of the reason for the difference has to do with the gap between short- and long-term interest rates.”

“The Fed’s earlier push to ease credit started in December 1990. After 25 months, the federal funds rate — the rate at which banks loan money overnight to one another — was down 4.3 percentage points. The average 30-year mortgage rate had dropped 2 percentage points, and 10-year Treasury yields had fallen 1.8 points.”

“Since the Fed’s cuts began in January 2001, the federal funds rate has taken a slightly bigger plunge, about 4.8 points. Yet the average 30-year mortgage rate and the 10-year Treasury yields have declined only 1.2 points.”

“These may not seem like big differences, but consider the proportions: this time, the Fed’s cuts are having only two-thirds of the effect on long-term rates — the rates that often determine the willingness of businesses to invest and the appetite of consumers to spend.”

“Of course, the Fed’s program is not the only influence on long-term rates. So what, exactly, is keeping the rates from falling further?”

“A year ago, analysts were asking the same question. The answers fell into two camps. One side said investors were looking forward to a quick recovery, which would raise the return on capital and the demand for credit. The other side blamed the vanishing federal budget surplus, saying demand for credit would rise as the government made plans to borrow more.”

“These days, with the prospects of more tax cuts and a potential costly war in Iraq, that second explanation is gaining relevance.”

” ‘It is the deficit,’ said Sharon L. Stark, managing director and chief fixed-income strategist at Legg Mason, a financial services firm in Baltimore. She predicted that the federal deficit, not including surpluses in Social Security, could easily reach $400 billion in the next few years.”