Why the Fed Blew It Today
The Fed blew it today. It should have reduced short-term interest rates -- at least by 25 basis points (a quarter of a percent) to send a clear signal to the market that it knows the threat of recession is bigger than any threat from inflation.
Inflation itself is almost never a problem. The problem comes with accelerating inflation. When does inflation accelerate? Not just because oil prices or food prices rise. Those price increases are largely the result of demand outrunning supply (see below).
No, inflation accelerates when companies have to continue to raise prices because wages are rising and productivity isn't. But these days American employees have no bargaining leverage to raise wages. Only 7.8 percent of private-sector workers are unionized. Besides, unemployment is on the rise. Under these circumstances, employers won't continue to raise prices, especially now that competition for every consumer dollar is increasing. They'll only raise prices to cover the increasing costs of supplies -- mainly energy. But this won't cause inflation to accelerate. It will just result in a price increase.
The Fed blew it. Consumer confidence is plummeting. Employment is falling. 1.2 million homes are already foreclosed upon, and banks are tightening the noose around a trillion dollars of credit-card debt. The Fed could have helped a small bit by cutting rates and sending a clear signal it would continue to do so in order to avoid recession.
But it didn't. I fear we're in for a bad one.
Inflation itself is almost never a problem. The problem comes with accelerating inflation. When does inflation accelerate? Not just because oil prices or food prices rise. Those price increases are largely the result of demand outrunning supply (see below).
No, inflation accelerates when companies have to continue to raise prices because wages are rising and productivity isn't. But these days American employees have no bargaining leverage to raise wages. Only 7.8 percent of private-sector workers are unionized. Besides, unemployment is on the rise. Under these circumstances, employers won't continue to raise prices, especially now that competition for every consumer dollar is increasing. They'll only raise prices to cover the increasing costs of supplies -- mainly energy. But this won't cause inflation to accelerate. It will just result in a price increase.
The Fed blew it. Consumer confidence is plummeting. Employment is falling. 1.2 million homes are already foreclosed upon, and banks are tightening the noose around a trillion dollars of credit-card debt. The Fed could have helped a small bit by cutting rates and sending a clear signal it would continue to do so in order to avoid recession.
But it didn't. I fear we're in for a bad one.
posted by Robert Reich | 3:55 PM
26 Comments:
To say that the Fed 'blew it' is to imply that they could have made a real difference here and now. But what can the Fed do to fix decades of excessive debt accumulation? It is far, far too late now. Ludwig von Mises articulated this endgame long ago. Now that the credit contraction has begun nothing can bring the phony wealth back. Perhaps you or others will point to this blog entry in a year's time when the depression is well underway and say, see, we told you so! I write this comment only so that if people do ever look back for answers they are not too quick to assume that anyone who questioned the authority of the day was right by default. Are we really to believe that further Fed cuts would have made the difference? What we need now is not leadership that tinkers but leadership that challenges our basic assumptions. The Fed is naive and impotent and has gaily overseen the greatest assortment of financial bubbles in history, which were superimposed on a generational credit bubble. Plenty of lip service has been paid to moral hazard but it always seems that the current intervention may be justified on the basis that 'moral hazard is something to be worrying about when the crisis is over' (as if that is going to happen). Perhaps we should be asking why the Fed even exists and whether or not we would be better without? One might hope that when all the interventions have been exhausted and things are bad enough we might finally accept that financial cycles are a normal, healthy process and that attempting to prevent them only amplifies the eventual disaster. But more likely, this depression/financial holocaust will be so incredibly painful that folks will not be able to accept that it was the consequence of prior excesses, and instead will choose to put their faith in the next 'expert' to save them ... There really is no accounting for folks.
Robert,
If we don't have accelerating inflation, we certainly have creeping inflation. (many would say more than creeping).
When the Fed started cutting rates last year, the $USD started sliding faster & oil commenced its march to present heights. There is definite correlation there...though I don't have the bona fides to prove causation.
Consumer confidence is falling precisely because consumers now see prices of everyday items rising noticeably & they are unable to demand wage increases (as you note).
We are already seeing front line commodity employers raising prices (eg, Dow Chemical +45%). Dow made it clear that they won't take losses in order to keep customers - they are raising prices now & the next step is reducing production.
Airlines are clearly in trouble (except for Southwest because of their prescient fuel hedges) - they are alienating customers with fees & reducing services at a slash/burn rate.
These are the canaries in our coal mine.
If the Fed eases further with the EU still on a tightening bias, the $USD drops even more, oil rises & we get more of the same. Luckily most Americans are not smart enough to head for the exit & hedge their exposure to rising commodity prices by selling $USD assets & buying forex or commodities directly. A vicious spiral would ensue.
The Fed is clearly between the rock & a hard place and are hoping we'll squeak through.
Best,
-GDL
The Shadowstats web site by John Williams is great reading, among the financial blogs. Here's another URL:
http://www.dollarcollapse.com/iNP/view.asp?ID=65
Thomas Friedman in yesterday's NYTimes suggested oil execs are like Big Tobacco execs who worked long to suppress the link between tobacco and lung cancer. I used to live near the Kentucky Tobacco Research Institute, which was located on an out parcel of land on the parking lot of the University of Kentucky's football stadium. It was a small one story building not much larger than a two car garage.
Robert said...
"I fear we're in for a bad one".
What a bizarre twist of fate that would be; eminent depression-era scholar now Fed Chairman presiding over a depression himself, possibly of his own making.
We're in for a bad one regardless of what the Fed does to FFT rates.
Today's decision was politically driven.
Oh come on. If anything the Fed should have raised rates. As an earlier commentator said, we need a leader that challenges the fundamental structure of the economy to fix a collapse that 30 years in the making. Here's my analogy:
America is an obsessive compulsive gambler (actually, a consumer) who walked into a casino with a lot of wealth. Through bad bets (federal deficits), he lost of his wealth. So then, he goes and borrows some from the house (current account deficits). Now the house doesn't want to fund this gambler any more (selling the dollar), but the gambler won't walk away from the table. "One more bet (one more rate cut)," the gambler says, "and everything will be fine." Meanwhile, the casino does a credit check and realizes that the gambler owes much more to other casinos (Social Security, Medicare, housing bailouts, Iraq) and seriously wonders whether the IOUs are any good.
So that's where we are right now. We have declining aggregate demand (can't sit at the table any more) and dollar debasement (too many IOUs). Monetary policy is ineffective in our situation. If the house lends us more money are we going to use it to productively to purchase capital equipment or a Prada purse. Unfortunately, the last twenty five years, it's been more likely the latter.
So please no more rate cuts, no more bailouts or general stimulus packages. Use the remaining fiscal bullets that we have on things that really matter: energy independence (oil and renewable), increasing export capacity, conservation, etc.
Robert Reich,
You are a moron. If Fed cuts 0.25% and that pushes oil price up by another 20%, most of the nation's airlines and trucking companies will be wiped out. That's no improvement to the economy, right?
K, interesting post: Dr. Reich you
have less and less to offer the young people of this country other then tired old economic stimulus hits that add both to consumer and federal debt levels. Get off your old Demorcatic party lines and use your brain for once, the FED does not set interest rates the market does, get on board.
I think this blog may need comment moderation. Between the greenhouse denialist on the last post, and the monetary fundamentalist on this one (the Fed has no influence on interest rates?), it's getting kind of stupid down here...
Dr. Reich,
With all respect, you are making an enormous mistake in economic thinking when suggesting we can ignore inflation and return, however softly, to an addiction of relying on Debt to compensate for stagnant wages. I say this realizing that credit controls are stronger now, as they should be. Why, with gasoline prices at $8.00 a barrel in Europe is the ECB bank raising interest rates to counter inflation? Wage inflation is not excessive here either.
We need a recession to clean up the Out-of-Balance aspects of our economic model, particularly zero Savings and an illiquid `Safety Net´ in the banking system.
I think I've explained clearly in earlier posts how to over next 4-6 years come to a better balance between Consumption and Investment as drivers of our economy in concert with increased savings. The 70% Consumption of GDP days are over.
We need to slowly correct the imbalances by a combination of savings, new jobs and selective taxes, intelligent tax cuts and budget cuts to financially support greater investment in our social infratructure and tax credits for stimulating move to Alternate (green) Fuels, Fuel Efficiency, and Conservation... without exploding our Deficits any further.
Let's not return to Greenspan's disastrous monetary policy of printing money, encouraging total credit market debt to grow faster than GDP (4 times faster in recent years) inevitably leading to financial crisises like we´ve had in the past and are having again now. For it´s doubtful we´ll survive the next one!
The way to stabilize Consumption and the economy in the near term is to reduce tax rates for lower-middle class (who account for 85% of Consumption) offset by an increase in progressive tax rates for top 10% (who account for less than 10% of Consumption).
Republicans still cling to the propaganda that tax cuts for the rich "Trickle Down" to powerfully stimulate the economy and to generate jobs for 85% of the population. Clear evidence shows just the opposite happens... Consumption drops unless you have a Greenspan policy of exploding Debt 2000-2007 to supplement stagnant lower/middle class wages.
This ahsd been proven a totally nonsensical policy ... although there may be an argument for corporation tax credits for specific goals or tax cuts providing there's a creative way to insure resulting tax savings are reinvested in America.
A cut in the Fed rate is the last message we need to give the rest of the world now which is sensibly doing just the opposite ... mature countries that don't underestimate the consequences of rising energy/commodity prices as being a "momentory blip," but rather as a serious permanent ongoing threat of some scale to world prices.
Tinkering with a 0.25% drop in the Fed rate will achieve nothing good and may even lower confidence in the Dollar with resultant Catch-22 effect on rising oil prices. I'm surprised at your even thinking about this as making any sense.
Mr Reich, you're painfully mistaken about Fed rate cuts. Are the Fed/Wall Street/Government supposed to inflate their way out of this crisis? No, the US should go through a period of saving instead of spending.
Household debts are already totaling 130% of annual power purchasing parity, and you still want to stimulate spending by throwing cheap money? Haven't you learned anything from the Greenspan years? Cheap money isn't the answer, it's the problem!
You'd better read up on Von Hayek and Von Mises.
I think its time for Americans to dump their oil stocks. Case in point: My husband's boss has invested in the oil market. He is making a lot of money from his stocks. Meanwhile, his company is tanking. They cannot sell their product, which relies heavily on gasoline. Which is better? The fed may have blew it today, but the bottom line is fuel prices. It is crippling our economy. The housing crisis is just one sector. The fuel crisis is catastrophic.
A split agreement between k and Dr. Reich.
Dr. Reich is correct in that we are not experiencing monetary inflation and that prices are rising simply because demand is far outstripping supply.
K is correct in that our problems are due to excessive debt. The government is basically bankrupt with 10 trillion in debt, we run huge trade deficits, and between upside-down mortgages and SUV loans, and outrageous credit card debt, most Americans are facing a future they can't begin to imagine.
Trying to spur the economy by the Fed lowering interest rates and encouraging more debt is not the answer. Besides, it's not working! If the banks won't loan at 2% another 1/4% won't make a difference.
There is a way to avoid the coming depression. Just as the .com boom of the nineties released a flood of private investment capital which provided a huge increase in employment and enough tax revenues to start paying down the government debt: the same can be done if the government announces and absolute WWII type commitment to shifting our economy from fossil fuel based to renewable energy based.
During the .com nineties, people who were hired at the startups were taking their money and sinking it into more startups or starting their own spin-offs! Money was being recirculated in the economy at an incredible rate. The same thing would happen with the new alternative energy economy.
If Obama doesn't commit to this, we are truly toast.
Auros: The FED follows the bond market. Notice how mortgage rates have suddenly moved up along with the 2yr bond yield. If the bond market continues to say inflation is the problem then the FED will have no choice but to follow along.
The question to ask is “Does raising or lowering rates have an effect on global prices”? If the Fed raises rates, would it slow down inflation in the oil and food markets? These markets are gigantic and beyond our money supply. The Fed can do anything it wants but it’s not going to greatly impact rising oil prices.
I'm almost embarrassed about being part of this blog. It seems to attract non-intellectuals republicans. The republican party must be monitring the democratic blogs and sending the dogs to "obfuscate" the issues.
Maybe that will give this blog a break while they go look up that big word.
anonymous 9:57
You are the "non-intellectual" because not a word you said makes a bit of sense. We all have a brain regardless of party to reason whether some ideas are ridiculos or not.
Bernanke’s Thoughts on the Great Depression, c. 2005
Interview by Randall Parker
An excerpt:
Parker: Are there any lessons from the Great Depression that need to be relearned?
Bernanke: First that a central bank’s primary responsibility is the maintenance of price stability… The second lesson is that the financial industry is a special industry in terms of its role in macroeconomic stability. Major upheavals in the financial system can be extremely disruptive to the economy as a whole and therefore the central bank and other government institutions have a particular obligation to make sure that financial stability is preserved, that banks and other financial institutions are well capitalized and well managed and that there exists a mechanism for responding in the event of crisis, such as the discount window or a deposit insurance system …
This pretty much tells us that the Fed is going to continue to be Big Banks number one lapdog. They'll delay raising rates as long as they can to protect these banks and in the process put everything else at risk.
Maybe you ought to spend some time around the President of Brazil who says he's focused on the working people (rather than writing them off as mere economic components lacking any leverage to demand compensation in light of inflation.)
``I worked a long time inside a factory and have lived in this country with inflation of 80 percent a month,'' said Lula. ``I know the impact this has on a person who receives a monthly salary. And it's these people I want to protect, because by taking care of them I can take care of everyone else.''
"I'm almost embarrassed about being part of this blog. It seems to attract non-intellectuals republicans."
As a independent voter, ex-democratic party person, your description is rather weird and off the mark. Rather its good that Dr. reich a member of the elite Democratic Party get to hear other voices. It lets him know that in order to be a effective voice for change the Democratic Party needs to reach out to independent voters that do not believe in such silly notions that Global trade is always good and those that get their job wacked can just be retrained; or that cheap money and debt is good for a economy that is has a GDP with 70% based on consumer spending and 20% gov't debt spending.
Maybe you should read the posts with an open mind and quit thinking like a robot.
Mr. Reich:
You are probably feeling pretty good about the Clinton years.
What a mess Bush (et al oil buddies) have us in now. The war is sinking us. Agnecy budgets are cut, so we have enough oversight.
I wonder if the Bush team will get us to a DEPRESSION before next January.
"Anonymous said...
Mr. Reich:
You are probably feeling pretty good about the Clinton years."
Maybe. But not good enough to have endorsed Hillary when she was still in the race.
http://liberalreader.blogspot.com/2008/03/chocoholic.html
1) In this post, Mr. Reich says:
“Given the US recession and slowing of European economies”
In the post I am now commenting on, Mr. Reich warns of:
“the threat of recession”
and implies that we can still:
“avoid recession”
So, on June 9th Mr. Reich seems to assert that the US is currently in a recession and on June 25th Mr. Reich implies we can still “avoid recession”.
Which is it?
In the interim, has Mr. Reich been persuaded by the evidence? He is, after all, trained in the law and lawyers can be pretty good at evaluating evidence. If so, could he please inform the blatant propagandists at MSNBC and AP?
2) I respectfully disagree.
I think the Fed has engineered the ever elusive “soft landing” and was correct not to overshoot. Q2 will see slow growth roughly similar to Q1 and we will see accelerating (but less than stellar) growth through the rest of the year. The price of oil will continue to create a drag on the growth of world economies for years to come.
If we want to eventually return to a more healthy economic growth rate worldwide, we need to Drill Here, Drill Now, Pay Less. Otherwise, world economies will grind to a halt, venture capital will vanish and we will NEVER get to that next generation of energy sources.
k:
Excellent treatise. I may not agree with it all, but that might be due to my lesser knowledge of the subject. I always hated monetary theory.
Geez! I thought most of the postings here were very intellectual and most seemed to express a pretty fair knowledge of economics. Maybe I ain't real bright.
Most, of course, excludes sbvor.
I am, by the way, in the camp of raising rates rather than lowering them. I can accept that we are not in a typical inflationary spiral but I fear that astronomical price rises in oil and food are the major culprit at this time. Oil prices alone can cripple the economy and are well on there way to doing it.
Since we can't drill our way out, we can't eliminate deficits overnight, we certainly can't spend our way out in the near term, it would seem our only salvation is a stronger dollar. In our current fiasco I'm not sure higher interest rates will produce a significant rise in the dollar, once people lose faith, restoring belief can be difficult. We also seemed to have entered a chicken and egg dilemma with oil and the slumping dollar. Which one is causing which one?
It would appear that credit is not desirable at half the price.
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