Wednesday, January 20, 2010
Fed up with the Fed
The article talks about the Federal Reserve's current policy of keeping interest rates near zero, "zero interest rate policy". The policy has helped consumers spend more than they normally would, but that increase in spending has not been much, 2.7% over the past 12 months. The problem with keeping interest rates consistently low is that it causes inflation. The article cites the increases prices of gas lately. The article argues that while inflation may not be horrible right now, the fed can not keep interest rates at zero indefinitely and expect everything to be okay.
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3 comments:
Undoubtedly, the Fed will need to raise the interest rates sometime in the future, but the key question is clearly when?
In the July 2009 Monetary Policy Report to congress, the Fed made it clear that interest rate was to remain low for an "extended period of time" citing that tight credit conditions that households and businesses still face, and the slow recovery of unemployment as justification for the low rates.
Even now, the unemployment rate is holding steady at 10% and financial markets and institutions are still fragile. An increase in interest rates may cause the instability that may cause the double dipped recession that many fear especially after last month's unemployment data of 85,000 job losses in Dec.
Nonetheless, countries like the Australia have raised their interest rates. Making small incremental increases can be a good thing as it allows for continued short term investments that fuels growth.
Isn't a large part of the US economy's recovery dependent on people who have disposable income going out and buying consumer products which then fuels production - which in turn fuels hiring which reduces unemployment, causing a feedback loop?
Why aren't we asking the people pushing up our national savings rate to go out and spend?
And if we are interested in more long-term growth with a higher savings rate than has been the trend for the last twenty years, then why are we not planning for a short-term understanding that unemployment won't go down?
Maybe I'm ignoring policy tools to manipulate short-run economic growth, but it seems we either need to foster consumer spending or live with the crappy economy and increase our savings to potentially fuel more sustainable growth later.
In Bernanke's Jan. 3rd statement, he addressed the interest rate issue, saying that the problem cannot be fixed using monetary policy, it must be helped using regulation or fiscal efforts. With Bernanke being a fixed rule, little change to interest rates kind of policymaker, I do not think that the interest rates will increase any time soon. This being especially true with little progress in the battered housing sector and low investment spending, while inflation nearly stagnant. However, just as the article says, if inflation becomes a problem, with people all the sudden spending again, interest rates will most likely increase. So, I do not see interest rates increasing at least until there is a significant increase in inflation, causing monetary policy to then target inflationary problems.
However, when the Fed does change the interest rate, I think it will be a monumental event. Just as said earlier the key question is when, but also something to ponder is by how much. It surely will not be much, (likely to be incremental) but it will be interesting to see how markets, consumers and investors respond.
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