Federal Reserve & Interest Rates

You may have heard, in addition to the possibility of a recession, that we are dealing with stagflation. Stagflation is the combination of rising inflation and the decreasing job market. This type of economic problem has to be dealt with very carefully, or certain actions could make matters worse.

The problem is that in order for the Federal Reserve Board to help the problem of unemployment the money supply would have to be increased so that more jobs can be created. The only problem with that is that when the money supply is increased, inflation is likely to go up. Then, in order to help the problem of inflation, monetary policy would have to tighten, which would reduce the available money for more jobs. This in turn could increase the unemployment rate. A sole focus on either recession or inflation could worsen the other.

Investors and economists are obviously divided on the issue. Is it more important to focus on employment growth or keep prices from rising too high? Should the Fed try to address both issues at once? How would they do it?

The employment rate has slipped ever so slightly in different regions of the United States in recent years. The national unemployment rate, however still seems to be hovering around the same 4%-4.5% average. The availability of jobs weighs heavily upon the next changes in monetary policy.

Inflation due to the cost of energy, imports, and money infused to liquidate the markets is a continued issue. Board Governor Frederic S. Mishkin stated in a recent speech: “…as long as a central bank has an independent monetary policy–that is, it is not locked into a fixed-exchange-rate regime in which its hands are tied–the rate of inflation is determined by monetary policy.”

Governor Mishkin also said, “What determines the overall inflation rate is not relative prices for one category of goods and services but rather the balance between overall demand and supply in the economy, which ultimately is influenced by monetary policy.”

His discussion on inflation was relative to his speech on globalization. Simply put, globalization is the interdependence and integration of countries around the world for economic, technological and ecological support. Instead of being self-reliant, the United States depends several factors on other countries. Mishkin stated, “Globalization, because it makes markets more competitive, also has the potential to spur productivity growth. Higher productivity growth can lead to a reduction in inflation because it directly lowers prices if monetary policy does not become more expansionary.”

Once again, all we can do it wait and see what the Federal Reserve will decide. We know now that recession is not inevitable, neither is high inflation. We are possibly looking at some hard months ahead.

What is Recession?

Basically a recession is a decline in real economic growth and a decline in a country’s Gross Domestic Product (GDP) for half of a year or more.  In a recession, the overall economic indicators reveal severe changes, which typically includes a sharp rise or fall in prices (inflation or deflation).  If recession continues for an extended period of time, it is called a depression.

What causes a recession?

There is much debate over the causes of recession.  Economists and monetarists rarely agree on which factors are responsible for economic decline.  It is perhaps that there are several different factors, when experienced together, that cause tremendous economic decline.

Mishandling of the money supply, weather conditions, war, and the inflation of import costs (perhaps the decrease in the forex (foreign exchange) value of a country’s currency) could all be contributing factors to a recession.

What is happening now?

These various factors are alarming to consider, as they seem to describe current conditions.  Mishandling of the money supply is suspect, as facts and figures show an incredible deficit under the current presidency.  The current war has without a doubt taken millions, maybe billions, of US dollars, and it tolls our economy greatly.  The inflation of energy costs has yet to be stabilized.  Even with the recent rate cuts done by the Fed, inflation is still a variable.

The value of the dollar is still declining against the Euro.  An all time low of 1.41 was hit twice this month, and there are no signs of rebound just yet.  The Canadian dollar had some brief moments of equality with the US dollar, for the first time in about 30 years.

With all of these economic uncertainties, recession looks more and more like a possibility in the near future.  Residential real estate has also taken a huge toll on the economy.  If that doesn’t start to pick up, it can remain a destabilizing anomaly for a long time.

There is much rumor of a four year long recession about to come underway.  Former Federal Reserve Chairman Alan Greenspan says, “My own guess is the odds are less than 50-50 that we’re heading to a recession, but there is no question we’ve got significant pressure on home prices, which I expect to move down quite considerably lower.”

What can I do?

To prepare for a recession, there are several things you can do to secure yourself.

-Delay large purchases.
-Increase your savings.
-Cut down on spending.
-Know your business.  Some businesses are more inclined to experience great loss than others.  Research your market and expect consumer spending to decrease.  Try to determine the possibility of a lay-off in your company.
-Don’t panic.  Be a little frugal and you should survive.
-Find ways to make extra money and set it aside.

There is always a possibility that the economy will pull through.  The best thing to do is prepare for the worst and hope for the best.

When it comes to accessing the economy, the Federal Reserve Board has to evaluate several different contributing factors.  Research is done on a continued basis throughout the year, and economic data is released generally on a monthly basis.  If there are any sharp turns in a given area of the economy, it signals the Fed to investigate the issue, and possibly take action.

The Real Gross Domestic Product, or GDP, is one of the measured indicators for the condition of the economy.  The GDP is The total value of goods and services produced within the borders of the United States.  This data is reported quarterly.  The GDP allows the Fed can monitor the trends in the overall economic growth, the unemployment rate, and the rate of inflation.  This data helps determine the efficiency of current monetary policy.

Another economic factor is the Consumer Price Index, or the CPI. The CPI is designed to measure the change in price of a fixed market basket of goods and services. “The market basket of goods and services is representative of the purchases of a typical urban consumer. The index is intended to measure pure price change only.”

Data calculating the CPI is released on a monthly basis. The rate of change of the CPI is a vital measure of inflation.  If inflation accelerates or decelerates significantly, there is often a change made to monetary policy to steady the rate.

Non-farm Payroll Employment is yet another economic measuring tool.  It is an estimate of the number of payroll jobs at all non-farm businesses and government organizations.  This also reports the average number of hours worked per week and hourly and weekly earnings.  The non-farm payroll employment reading is reported monthly.

This report is an indicator of the supply and demand conditions in labor markets.  It also helps determine the pace of overall economic growth at the present time and possibly the future.

There is also something called the Advance Durable Goods Shipments, New Orders and Unfilled Orders that is recorded every month.  This economic reading contains data on shipments,
new orders, and unfilled orders for things like primary metals, fabricated metals, electric generating equipment, non-electrical machinery, information processing equipment, and transportation equipment, including civilian and military aircraft and ships, trucks, and automobiles.

If there is a rise in orders and shipments, that signifies that demand is strengthening.  If demand is strengthening, then it is likely that employment and production will also increase.  If there is a decrease in orders and shipments, the opposite may be true.  This may also be an indicator of future business investment opportunity.

There are still more important economic measures that are taken that signal the Federal Reserve on the nation’s overall economic performance.  The stock index, housing starts, industrial production, retail sales, business inventory, and the yield on Treasury Bonds also play a major role in evaluating the state of the economy.

For more details on economic evaluation, visit the New York Federal Reserve education site.