Wednesday, 16 March 2016

Fed: everything normal, so go back to work

Writing about Federal Reserve's monetary policy is rarely exciting, same goes for reading comments about it.

I am sorely tempted to share my opinions about the Republican primaries instead. But since the situation on that front develops every day, I better hold back until things get more stable. There is one connection though.

The Republican party has since Obama's election set new standards in obstruction of the legislative process. It has had some bizarre side effects, such as "Government Shutdown" on a number of occasions.

The legislative gridlock has had one positive effect: any tendency on either side of the political spectrum to introduce "austerity" has been mostly curbed. The effect has been that the US as almost the only country has seen the public sector deficit develop according to the textbooks. As the crisis hit, government finances went deeply into red, providing stimulus to the economy. This stimulus has automatically been reduced as the economy recovered. No German-style destabilising "stability policy" here.

It does not mean that all is good, nor that I find political gridlock as a way to obtain an economic-political target is an idea to imitate.

Together with the timely (albeit rather distasteful) help to the banks, it does mean that the US today is in a better place than most of the other larger economies in the Western world. There has been a long period of economic growth, jobs that disappeared during the crisis are roughly re-created. Growth has been more subdued than seen in the years until 2007, but there has also been a significant improvement of the debt situation of the households, meaning that their savings have increased. That leads to slower growth in the short term.

Of course there are still a multitude of problems stemming from the fact that decisions on the fiscal policy are simply not taken. Still, the US economy is in a better state than the European economies.

Hence it is no surprise that Fed in general are upbeat: the US growth has survived a visible strengthening of the dollar and a slowdown in China. So there is only one way of interpreting Feds inactivity: the Open Market Committee simply finds that they are on the right path and are waiting for inflation to begin crawling up towards the 2 per cent target. And obviously, Fed finds itself on tract for further interest hikes during the year.

Whether it is 2, 3, or 4 hikes is not that important. Important is what Fed's analysis shows about the US economic growth. FOMC was not in doubt. We are on the right track and further rate hikes will follow as prices begin to crawl upwards.

What the markets should be spooked about is the capacity limit. Inflationary pressures begin to build as a shortage of certain kinds of labour begins to build. Inflation could also begin to increase if US companies hit their production limits. The fact is that nobody knows where the inflationary limits are. We just know that an awful lot of productive capacity has been dismantled after 8 years of crisis.

So no, further interest rate hikes are not taken off the agenda going forwards.

No comments: