2017 August 30

Fed Adopts Wait-And-See Policy Amid Curiously Low Inflation

Speaking at the Annual Jackson Hole Economic Policy Symposium last week, Federal Reserve Chairwoman Janet Yellen reiterated her position that another financial crisis would be unlikely in our lifetimes.
Indeed, the latest US unemployment data shows a 16-year low of 4.3%. And economists at the Chicago Fed estimate that this level could fall to as low as 4.1%. A study however by the Federal Reserve Bank of San Francisco might indicate that this unemployment rate might be too low, and that for healthy economic expansion, the unemployment rate should fluctuate between 4.5 and 5.5%. Despite these record numbers in low unemployment however, inflation has curiously not seen any upswing, but in fact, a decline.

Wait And See Approach

The Fed now finds itself in a curious position about whether or not to raise interest rates. The one option is to keep rates low to drive economic growth that might lead to a further reduction in unemployment in the hope that inflation rises. However, speaking to the Wall Street Journal, economist Laurence Ball of Johns Hopkins University said “It could be that employment drops down to 3-something [percent] and stays there and inflation stays low”.
The other option of course is to raise interest rates, slowing down borrowing and possibly pushing inflation even lower. Speaking to CNBC, Fed Governor Jerome Powell said “It’s too soon to make decisions about particular meetings and whether to raise rates but I think we have the ability… to be a little bit patient.”

Recession Alarm Bells

While each economic cycle should be studied on its own, some similarities to previous recession periods are creeping up. The great recession and the dot-com bust both occurred after periods of Fed tightening. In April 2000, employment was at a low of 3.8% - as it was also before the mild 11-month recession of 1969-70. And short-term interest rates are yielding more than longer-term interest rates resulting in an inverted yield curve – a measure that has correctly predicted the last 7 recessions.

Keynesian Economics to the Rescue?

Should US President Donald Trump quickly adopt spending on infrastructure injecting a rapid growth in GDP, the curve inversion could be avoided. With the debt ceiling fast approaching, congress will use the looming threat of a shut-down to twist President Trumps hand into giving in on various issues and budgets as they have in the past. And following Hurricane Harvey, with damages estimated at a cool $42 Billion, Republicans will be scrambling to receive government funds for repair and rebuilding. This short-term injection would be new debt on top of a fast approaching $20 Trillion Debt Ceiling as well as a ballooned $4.5 Trillion Fed Balance Sheet who has expressed the intention to wind down their quantitative easing program.

US Inflation Rate (%)

US Unemployment Rate (%)

Federal Interest Rates (%)