America is clearly not in a recession, the government is ramping up spending, corporate profitability is recovering, the stockmarket is booming, and the dollar is extremely weak. Under the circumstances, what would be a typical expectation for central bank interest rates? Let's compare with other countries - the EU has a stagnant sluggish economy in its core countries of France and Germany, along with a strong currency, so its rates are relatively low at 2%. The UK economy did not have a recession and is chugging along nicely, and the Bank of England base rate is 3.75%. Canada's rate is 2.5%. Australia's is 5.25%. New Zealand's is 5%. So what is the Fed doing with an interest rate of 1%? It seems utterly at odds with the news from the economy and the developments in the stockmarket and the dollar. They originally used low rates to stave off what they saw as a risk of a Japan-style deflation. Now that danger has clearly passed a long time ago, why are they sticking with the same policy? It seems somewhat strange to say the least. What goal is the Fed trying to achieve with this low rate, seemingly at odds with conditions? Are they trying to *create* inflation, or an asset price boom, or a weak dollar? If so, then we can predict when rates will start to rise - when either of those three conditions start to get out of hand. And by that time it will be too late to pre-empt the effects - the rate-tightening cycle will have to go much higher than if they turned off the spigot now. Any suggestions as to why the Fed is acting this way?
(a) and (c). at some point the issue of china being (in effect) the 51st state thanks to its status as MoLR and a pegged currency will have to be dealt with. by who, i don't know, both parties are in deep...
Cutten, I think the Fed doesn't see any inflationary threat and does see a danger to the economy if it raises short term rates now. Also, long term rates which are set by market forces are not moving out of line with what the Fed is doing.
... spells it out for you in his Jan 4th meeting in San Diego. https://www.federalreserve.gov/boarddocs/speeches/2004/20040104/default.html
Subtract the GDP components that rely on debt refinancing, home building, and corporate earnings based on lower rates- subsequent dollar devaluation. Adjust trade deficits for the dollar devaluation. The numbers are not looking all that great. Consider no new job growth, add existing job losses (EK recent example), and the so called economy is not doing all that great to speak politely. What is the FED to do?
What is the FED going to do when the Arabs decide they ONLY want Euros for oil ?? How can they say there is little or no inflation ? It could be the economy is more shakey than they care to admit. If we have another terrorist strike on US, Fed has only one point to play with. I would have thought he would raise rates to at least give 2 points to adjust downwards if we are hit again.
Greenspan is just trying to cover his own ass and reputation after making the biggest financial blunder in history. That is, he bought into the "productivity miracle" ruse right at the market top, endorsing bubblenomics. Now he's pulling out all the stops to make everybody think he done good. He'd rather destroy the financial structure of the entire Western world than admit he screwed up so big. Greenspan is one GIGANTIC ASSHOLE!!
Thanks Student - I still don't see him give any justification for rates being 1% (i.e. negative in real terms) as opposed to say 2-2.5%, which would still be extremely low rates. The arguments he puts forward support low rates, but not (IMHO) rates lower than inflation. Current rates are implying an attempt to ward of impending deflation and economic stagnation, something that is not on the horizon. Another thing missing from his argument is an assessment of future economic developments. The Fed should be setting rates based on the prospects for 12-18 months ahead, not the next few months. He is basically saying that 2004 and early 2005 will have a continuing sluggish labour market. IMO he is incorrectly extrapolating the usual labour sluggishness you get in almost all early stage recoveries, and assuming it will continue. If you look at almost every recession and subsequent recovery, this does not turn out to be the case.