Federal Reserve & Interest Rates

In a speech before the Economic Club of New York, Fed Chairman Ben Bernanke see continued growth for the economy into next year.  He admits though that growth is likely to be slow due to a number of factors.

My own view is that the recent pickup reflects more than purely temporary factors and that continued growth next year is likely. However, some important headwinds–in particular, constrained bank lending and a weak job market–likely will prevent the expansion from being as robust as we would hope. I’ll discuss each of these problem areas in a bit more detail and then end with some further comments on the outlook for the economy and for policy.

Many economists believe we could be entering a jobless recovery phase, as it could be quite some time before the job market begins to recover.  Some believe the unemployment rate could reach as high as 13% before job creation starts again.

With inflation concerns still minimal at this time, he states that low interest rates will likely be warranted for some time and while some critics have called for higher interest rates, it could be as much as a year or more before we see any significant rise in the federal funds rate.

With banks expecting more loan losses from a weak housing market, a number of institutions have been hoarding cash, which has constrained bank lending to a degree.  Weak consumer spending has also caused credit demand to be well below normal levels, although those who are seeking credit are finding a difficult time of it.

While the banking system hasn’t fully recovered, it has stabilized somewhat and now that banks have sufficient capital reserves, the Fed has begun to ramp down it’s liquidity programs.  Although it’s balance sheet activity has slowed of late, it would not be surprising if we were to see the Fed use this tool once again next year if inflation concerns remain muted.

Although the economy returned to positive territory last quarter, an uncertain labor market is likely to put a damper on consumer spending and the holiday shopping season ahead.  On Friday, the Labor Department issued it’s October job’s report, which showed higher than expected job losses once again.

The unemployment rate rose from 9.8 to 10.2 percent in October, and nonfarm payroll employment continued to decline (-190,000), the U.S. Bureau of Labor Statistics reported today. The largest job losses over the month were in construction, manufacturing, and retail trade.

Now that unemployment has broken into the mythical double digit territory and slightly faster than many economists were predicting, it may give the government pause as it discusses exit strategies and an end to monetary and fiscal easing.  The labor market could very well put a damper on economic recovery over the long run and it could spur more fiscal spending into the new year.

This year’s stimulus package, while it also included tax breaks to spur consumer spending was also designed to create about 3 million jobs over a period of three to four years.  Thus far, little more than half a million jobs have been created and it pales in comparison to the over seven million jobs lost since the recession started.

Although the labor market typically lags behind the economy, some economists are predicting it could be as much as a year if not more before job creation begins again and that the unemployment rate could reach as high as 13% by then.  Even after the labor market starts to recover it liable to be a long and slow process, where we could still be over the double digit mark, two or three years down the road.

Federal Reserve Chairman Ben Bernanke gave an overview on Monday, on the impact of the financial crisis on Asia’s largest economies and it’s policy responses.  The growth in global trade allowed the financial crisis which began it this country to transmit it’s effects to the rest of the world, and Asian economies were hit hard but aggressive policy actions by many of those countries appears to have paid off.

In September and October 2008, as you know, the global financial crisis intensified dramatically.  Concerted international action prevented a global financial meltdown, but the effects of the crisis on asset prices, credit availability, and consumer and business confidence resulted in sharp declines in demand and production worldwide.  Reflecting this worsening economic climate, Asian GDP growth slowed further in the second half of 2008. 

For the region as a whole, the economic contraction in the fourth quarter of 2008 was pronounced, with activity falling at an annual rate of nearly 7 percent.  The fourth-quarter declines were especially dramatic in Taiwan and Thailand (more than 20 percent at an annual rate) and in South Korea and Singapore (more than 15 percent at an annual rate).  Among the major Asian economies, only those of China, India, and Indonesia did not contract during the crisis.

For most Asian countries, the severe drop off in global trade as well as disruptions in international capital flows played a large factor in the recessions of those countries.  However, low inflation levels allowed most of those countries to take aggressive stimulus actions and their economies appear to be on the brink of recovery.

Large trade and capital flow imbalances helped transmit financial instability to their economies and Bernanke points out that efforts need to be taken in the future to prevent this.  The United States need to increase it’s national savings rate but the large federal deficits expected over the next decade may make this difficult, on the flip side, Asian countries could reduce their overall savings rate by promoting domestic consumption, which may also prove difficult.

The lessons learned from the financial crisis has proved that global economies must take cooperative fiscal and monetary policy measures which are mutually beneficial.