While
nearly everyone seems convinced that the economy is improving and buy-the-dip
is the right strategy, the Fed is having increasing concerns about what to do
if reflation does not take hold.
The Wall Street Journal discusses "What if?" scenarios in Fed Weighs Growth
Risks.
Federal
Reserve officials are beginning to debate quietly what steps they might take
if the recovery surprisingly falters or if the inflation rate falls much
more.
Fed officials, who meet next week to survey the state of the economy, believe
a durable recovery is on track and their next move—though a ways
off—will be to tighten credit, not ease it further. Fed Chairman Ben
Bernanke has played down the risk of a double-dip recession and signaled
guarded confidence in the recovery.
But behind-the-scenes discussions at the meeting could include precautionary
talk about what happens if the economy doesn't perform as well as expected.
"If events in Europe evolve so that they have a more severe and broad
impact on financial markets, then the scope of the problems for the U.S.
could be magnified," Charles Evans, president of the Federal Reserve
Bank of Chicago, said in a speech last week.
Brian Sack, the head of the New York Fed's powerful markets group, has talked
about "two-sided" risks to the economy—in other words, the
risk that growth and inflation could turn out to be lower than expected, as
well as higher.
"The European sovereign-debt situation is serious, and there are many
unanswered questions about how events will unfold," James Bullard, St.
Louis Fed president, said in Tokyo on Monday.
Officials don't rule out the possibility that markets could settle and the
economy could produce a few months of strong job growth and solid consumer
spending and business investment.
But there are other scenarios: if the recovery falters, or if inflation slows
much further and a threat arises of deflation, a debilitating fall in prices
across the economy. In such cases, there would be a few avenues the Fed could
take.
One is asset purchases. During the financial crisis, the Fed purchased $1.25
trillion in mortgage-backed securities on top of buying debt issues by Fannie
Mae, Freddie Mac and the U.S. Treasury. Mr. Bernanke has said the steps
helped to lower long-term interest rates, including rates on mortgages.
In any case, a new report by the Federal Reserve Bank of San Francisco, based
on projections for inflation and unemployment, suggests that the Fed may not
need to raise short-term interest rates to curb growth or inflation until
early 2012, later than is commonly expected on Wall Street.
The report cites a rule of thumb that the Fed tends to lower the
federal-funds rate by 1.3 percentage points if inflation falls by one
percentage point and by almost two percentage points if the unemployment rate
rises by one percentage point.
Based on that rule, the federal-funds rate—now near zero—would be
minus 2.9% under today's conditions and wouldn't need to move higher until
the first half of 2012, according to San Francisco Fed economist Glenn
Rudebusch. The analysis factors in the stimulus the Fed has provided with its
mortgage purchases.
"It seems likely that the Fed's exit from the current accommodative
stance of monetary policy will take a significant period of time," the
report said.
Risks
to Growth All on Downside
The reality is reflation has already failed and other than unsustainable
government spending (and massive increases in public debt), the US economy
would still be in recession.
Looking ahead, the risks to growth are all on the downside. Here are some of
them.
·
China
overheats and has to step on the economic brakes
·
Spain
or Italy need Euro bailouts
·
Property
bubbles in China, Canada, Australia pop.
·
Austerity
measures throw the Eurozone back in recession
·
Huge
public worker layoffs in the US
·
US
housing demand weakens further, housing prices slip, construction dips, and
inventory rises from already high levels
·
US
unemployment starts to rise
·
UK
heads bank in recession
·
Congress
starts huge trade wars with China by labeling China a currency manipulator
and employs large punitive tariffs
I expect everyone of those to happen with the possible exception of labeling
China a currency manipulator. Thus, this is not a case of what the Fed will
do "if" the recovery fails, but rather what the Fed will do
"when" the recovery fails.
Bear in mind that the only semblance of economic recovery is from government
spending, nearly all of it wasted or taking from future demand, thus the
reflation efforts have already failed.
Finally, given an expected dramatic shift in Congress this November coupled
with increasing worry over deficits and public anger over bailouts to date,
reflation round two will play out much differently than did round one.
Mish
GlobalEconomicAnalysis.blogspot.com
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Mish's Global Economic Trend Analysis
Thoughts
on the great inflation/deflation/stagflation debate as well as discussions on
gold, silver, currencies, interest rates, and policy decisions that affect
the global markets.
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