About a year ago, we wrote a piece called, "Where do we go from here?" (December 2000, p. 14) In that article, we indicated that, "economic growth rates are moderating," but, "had not yet finished decelerating." That call didn't take genius to make, but after a year of decline, the question should be addressed again.

Robert W. Baird & Co.'s chief economist, Clare W. Zempel, recently completed a study on interest-rate reductions and the resulting impact on the economy. The findings may give us clues to help answer the question.

The study explores the impact of a 20 percent decline in an interest-rate index, composed of various long and short maturities. In March 2001, this interest-rate composite recorded a 20 percent decline from its peak — the 10^th time since 1954 that this has occurred.

The chart below shows average reactions to 20 percent weighted average interest-rate declines for the nine cases since 1954. Economic conditions start to respond favorably almost immediately. Six months following the signal, average PMI typically exceeds 50 and the change in industrial production, on average, moves into positive territory.

Perhaps even more interesting is the stock market's reaction to lower rates. The Dow Jones Industrial Average has typically increased more than 20 percent within nine months of the -20 percent interest rate signal. Because most of the stocks we follow are of the small- or mid-cap variety, gains potentially should be greater than the big-cap DJIA.

If our economic outlook is correct, we expect the economy to start to show signs of improvement into 2002. An upward bias has also nearly always followed major shocks (Pearl Harbor, Kennedy assassination, Kuwait invasion). As such, following the recent terrorist attacks on the U.S., the bias over the next year or so may also be upwards as an accommodative Fed stimulates the economy, industrial earnings recover and early-cycle industrial distribution stocks benefit.