Tag Archives: Federal Reserve Bank

2015: A Year Without Inflation?

Just a couple of months ago, market pundits were still discussing the possibility that the anti-recessionary Quantitative Easing (QE) policy of the Federal Reserve Bank of the United States would lead to “raging inflation” in the American economy. Have they been proven correct?

Hardly. Health care cost inflation, for instance, continues to remain below 5%, where it has lingered for the past five years. And energy costs have actually plummeted this year, with the price of a barrel of crude oil falling by well over 40%.

The implications of such low inflation rates may be profoundly positive for the American economy. After all, low inflation rates tend to be reflected in low interest rates. And when bank loan rates are low, organizations can better afford to finance speculative projects with costs that are significant in the short term and benefits that can only be recognized in the relatively distant future.

Such projects often promote the long term competitiveness of the American economy. Do you suport investments in renewable energy technologies, for instance? Driverless automobiles? Drugs to cure cancer? These investments are not likely to pay off in the near future, but in an extremely low rate environment, more organizations may be willing to pay for such projects.

There is a risk, though, that inflation and interest rates might plummet below the “zero lower bound” and actually become negative in direction. That hasn’t yet happened in the United States on an annual basis; even though energy costs have been dropping significantly and the Consumer Price Index (CPI) declined by a nominal 0.3% in November 2014, the annual CPI remained at positive 1.3% through that month.

But what could happen if inflation drops significantly below zero? If consumers and businesses become convinced that prices will continue to fall over time, they could stop spending money today and delay their purchases and investments in order to wait for a lower cost future.

Such debilitating deflationary psychology has plagued the Japanese economy for two decades. The European Central Bank (ECB) is reportedly worried that deflation and its effects may soon strike the European Union as well.

So there is a very real risk that an American bout of outright deflation may derail its economic recovery. Nevertheless, if the upcoming year features very low (or no) inflation, the economy of the United States may continue to serve as the engine that drives global prosperity.

Global Banking: BIS Disses Our Political Leaders!

Have you heard of the Bank for International Settlements (BIS)? It’s the financial institution that serves as a global clearing house for most of the world’s major national banks. U.S. Federal Reserve Bank Chairman Ben Bernanke, European Central Bank (ECB) President Mario Draghi, and their colleagues on the BIS Board of Directors help the organization coordinate regulatory activities at the international level.

You wouldn’t expect the BIS bankers to be a rambunctious group, would you? And yet, in the 2012 / 2013 Annual Report that they published last week, they heatedly criticized our political leaders for failing to adapt to the new regulatory realities of the post-Crash banking era.

How heatedly? Well, for instance, the text of the Report asserts that “Continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system.”

Ouch! For a banking regulator, those are fighting words! Clearly, the BIS Directors are peeved that our political leaders haven’t done more to restructure the global banking system.

You may not necessarily agree that our leaders have done too little to implement meaningful reforms. Former United States Representative Ron Paul, for instance, believes that they have done too much to regulate the banking system. In fact, Paul has stated that laws such as the Dodd Frank Act impose “disastrous costs” on Americans.

Whether you side with the BIS or with Ron Paul, though, perhaps you would agree that our banking regulators and our political leaders should coordinate and communicate their strategies more effectively.

The American Economy: Good News and Bad News

Ben Bernanke, the Chairman of the Board of Governors of the Federal Reserve System of the United States, must be feeling a bit frustrated by now.

As soon as he observes a set of consistent signals that the American economy is strengthening, he’ll likely opt to restore interest rates to higher (i.e. relatively normal) historical levels. On the other hand, as soon as he observes a set of consistent indicators that the economy is weakening, he’ll probably opt to move even more aggressively to stimulate the financial markets.

But what will he do if he doesn’t observe any consistent signals at all? In other words, what if he continues to take note of signals that contradict each other?

That’s what happened to Ben last week, when mixed signals about American consumers were released to the financial markets. Good news was embedded in bad tidings, and bad news in good tidings as well.

It’s Good News, Or Is It?

What good news cheered the markets? It was the report that American household debt levels had climbed for the first time since the pre-crash days of early 2008. Although excessive debt is undoubtedly a worrisome situation, many financial pundits interpreted the increase as a sign that consumers are feeling more secure about their jobs and their futures.

On the other hand, some noteworthy concerns were embedded in this good news. Apparently, the increase was largely attributable to surges in student tuition and automobile loans. Although automobile purchases undoubtedly stimulate economic growth, student indebtedness has been “in the news” lately because of its debilitating effect on the work force.

In other words, the news about debt was generally good, and yet one of its underlying causes was cause for worry. That’s the type of “good news, bad news” data that tends to drive federal regulators up a wall.

It’s Bad News, Or Perhaps Not?

Meanwhile, the markets received some unabashedly bad news too. The median annual household income in the United States has fallen to its lowest level since 1995. In other words, a full thirteen years of economic progress in the late 1990s and early 2000s have been fully reversed by the past four years of deep recession and the ensuing tepid recovery.

Furthermore, even though economists claim that the recession of 2008 and 2009 ended some time ago, annual household income has fallen each year for the past four years. Although the national economy has begun to grow again, consumer wealth has continued to slide significantly.

What good news can be gleaned from this depressing statistic? Interestingly, both the Democrats and the Republicans appear to have found a political “talking point” in the data. The Republicans claim that the recent slide in household income can be blamed on President Obama’s economic stewardship. And the Democrats counter that the recession actually began during George W. Bush’s term in office, and that his eight years of service failed to generate any permanent wealth for American consumers.

Quantitative Easing, The Third Generation

These mixed signals have persuaded Ben Bernanke to announce additional actions to stimulate the economy, but to implement them at a scale that is unlikely to trigger massive growth. Skeptics like Nobel Prize economist Paul Krugman have noted that unlike President Teddy Roosevelt, who advocated that the American government should “speak softly but carry a large stick,” Chairman Bernanke appears to be adhering to the reverse strategy.

On the one hand, he has vowed to prioritize economic growth and the employment of American workers as highly as the goal of monetary stability. That’s a major step in a new direction for a government bank that has long focused primarily on maintaining the value of the American currency.

In fact, the Chairman has pledged to maintain low interest rates for the foreseeable future in order to encourage lending and investment activities. And he has expressing his intention to engage in a third round of quantitative easing, a technical term that refers to the injection of federal funds into the financial system through the purchasing of debt securities.

Nevertheless, many pundits have noted that such actions may only affect the American economy to a limited extent. More drastic actions, such as the large scale nationalization of all of America’s global banks, were once debated but are no longer under serious consideration in the United States.

Muddling Through

Although the American equity markets continue to demonstrate significant strength, most economists predict that the United States will continue to muddle through its financial quagmire. With Europe remaining in a banking crisis and Asia troubled with slowing growth and territorial disputes, it is difficult to anticipate any external positive surprises that may jolt the American economy towards renewed prosperity.

Chairman Bernanke might thus be advised to acclimate himself to the current condition of mixed signals. Although “one step forward and one step back” might be a frustrating sequence for any one who wishes to make definitive progress, the American economy appears to be stuck in that very rut for the present and the immediate future.