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Facing the Recession :
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The Federal Reserve's decision today to neither cut interest rates nor raise them acknowledges the twin dangers of inflation and slow economic growth. We expect the Fed to keep its foot poised between the brake and the accelerator until it has a clearer picture of the road ahead. When it does move -- not likely until late this year -- a gentle tap on the brakes is most likely.
The Federal Open Market Committee (FOMC) signaled its intentions to financial markets in the policy statement following its meeting today. The statement notes that since its last meeting on April 30, the outlook for economic growth has improved a bit while "inflation and inflation expectations have increased." That moves the Fed a step closer to an interest rate hike.
Leaving the benchmark federal funds rate unchanged at 2% means that commercial banks will keep the prime lending rate at 5% -- low enough to ease resets on households with adjustable rate mortgages. It will also keep the rate relatively low on home equity lines of credit and on many small business loans, both of which are generally linked to changes in the prime rate. At its April 30 meeting, the FOMC cut interest rates for the seventh time since September, when the federal funds rate was 5.25%.
The continued stimulus should help the economy, along with a boost this quarter from the $117 billion in tax rebate checks that began to filter out in April and will continue to dribble into the economy into July. During late summer and early fall, Fed officials will be watching carefully for signs that consumer spending is falling off after the checks are spent.
Any urge that the Fed feels to cut rates again, however, will be curbed by rising prices for food and energy. Together, they sent the Consumer Price Index in May up at an annualized rate of 4.1%, raising concerns that the Fed's low interest rate policy is fueling inflation.
Odds are the Fed won't get a clear signal until after the summer. By the FOMC's next meeting, on Aug. 5, the late spring jump in oil prices combined with floods across much of the Corn Belt could push the annualized inflation rate up to 5%. Employment, however, will continue to shrink in June and July, and the first estimate of second quarter gross domestic product -- which will be announced on July 31 -- is likely to show a meager 1% gain, annualized.
Inflation hawks at the Fed won't find those numbers comforting; they want a rate hike to cool inflation, and the sooner the better, as far as they are concerned. But to Fed Chairman Ben Bernanke and like-minded members of the FOMC and the Fed's economic staff, no action remains the best course for the moment. As James Glassman, senior economist with JPMorgan Chase, puts it: "There is no dilemma [for them]. They see a weak economy offsetting inflation pressures."
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POSTED BY: Rodger Malcolm Mitch (June 27, 2008 07:40 AM)
Contrary to common wisdom, there is no historical evidence that low interest rates stimulate the economy or that high rates inhibit it. In fact, to a slight degree, high rates stimulate, because they force the federal government to pay more interest money into the economy.
Economies are measured in terms of money, with large economies having more money than small economies. Therefore a growing economy requires a growing supply of money.
This means, the only thing that can stimulate an economy is a growing supply of money.
Currently, our economy is starved for money. Many interest rate cuts have accomplished nothing. The $150 billion "stimulus package" will help a bit by adding money to the economy, though it is a case of too little, too late. $500 billion - $1 trillion would be far better.
Meanwhile, as I've been saying for 10 years (see the book, FREE MONEY), the Fed cannot cure stagflation. There is only one solution to stagflation:
1. Cure the inflation by raising interest rates.
2. Cure the stagnation with federal deficit spending.
There is no other cure.
www.rodgermitchell.com
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