Saturday, November 5, 2016

Interest Rate Hike - If Not Now, When?

By not demanding the right kind of growth and simply throwing money at problems we have delayed and are adding to a much larger crisis lurking in the future. Many of those already concerned about the strength of the economy and they will find little comfort in recent remarks made by Oliver Blanchard. The well respected 67-year old former International Monetary Fund Chief Economist indicated the U.S. economy is not out of the woods and the Federal Reserve should be sparing in their interest-rate hikes to guard against a downturn. As chief economist at the IMF in the post-financial era from 2008 until 2015 Blanchard is credited for moving the IMF away from the view that fiscal austerity is always the best medicine for an economy.

Debt Has Grown Faster Than GDP
His comments reinforce those made by Fed Chairwoman, Janet Yellen noting the benefits of a “high-pressure economy.” Blanchard went on to say allowing the economy to run hot has more benefits than costs and that  he’s less optimistic about the U.S. economy, as consumers and businesses confront diminished expectations about the future. Statements made by Yellen suggest that she agrees, at least in some part, with former Treasury Secretary, Larry Summers, who said that secular stagnation, or a lack of demand, is pushing down global growth. Yellen has said a disappointing economy may force economists to think about the economy in new ways.

Before the crisis, most economists thought the amount of output of goods and services was primarily driven by supply, Yellen said. “This conclusion deserves to be reconsidered in light of the failures of the level of economic activity to return to its prerecession trend in most advanced economies.” This line of reasoning is consistent with the Fed and the actions of central banks across the world. For years they have fomented policies to increase demand oblivious to the harm they were doing to the ability of markets to self-correct. Low-interest rates have punished savers, distorted markets, and caused capital to be allocated in nonproductive ways.

Blanchard indicated a chief reason the economy is not growing faster is that over the past few years several revisions lowering potential growth have created a situation where both people and firms have arrived at a point that they say “well, why should we invest a lot, why should we consume a lot?” This translates into linking our weak recovery to the anticipation of a mediocre future. Blanchard paints the somewhat patronizing picture that ordinary people and firms have no clue about potential growth but weakness does affect their decisions and tends to hold back demand.. This means reduced investment by business and consumers buying less and saving reinforcing the cycle of slow growth. Like many politicians, Blanchard points to increasing public investment and spending on infrastructure as a way forward. Sadly this type of spending often leads to building bridges to nowhere and costly boondoggles.

Historically Low Rates Create New Problems
Several issues remain that will shape our economic future, such as, when rates will rise, how fast, and how far. I have to wonder how long the central banks across the world can continue their effort to create demand before some other event or crisis force them to chart a new path. History shows that on average there is about  a 15% probability every year a recession will occur, because of the extraordinary low interest rates coupled with expansive monetary policies, we have avoided a business cycle contraction for longer than normal and it seems we are on borrowed time, sooner or later a downturn will occur and it could be a doozy.

In the past, I have expressed concerns about the games being played with currencies and speculated how the failure of any of the four currencies that currently make up the bulk of world reserves would be very destabilizing. As long as the central banks behind these currencies move in the same direction and march in lockstep the integrity of this rather closed system may be able to remain intact. Still, worries exist as to just how much ammunition remains in the arsenals of the central banks and I find very troubling the argument that conditions remain too fragile to begin a return to historic norms. Also, questions remain as to whether the world can handle additional government debt when rates begin to rise. As the world economy matures creating an economic foundation that is balanced and sustainable over the long term is of major importance.


Footnote; The limks below are related to subjects mentioned above.
  http://brucewilds.blogspot.com/2016/08/currency-games-scream-major-risk.html
  http://brucewilds.blogspot.com/2013/03/low-interest-rates-and-their-cost.html

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