US policy makers need to move beyond just rate cuts to keep recession at bay or else they will loose the grip
When the US economy sprinted through the third quarter
of FY 2007 at 4.9% (its fastest pace in the last four years), many felt that the worst was over. But, as the US Commerce Department, on January 30, came out with the latest numbers, it only provided further credence to the arguments that the US is knocking on the door of recession, if not already in.
Managing just 0.6% growth rate - its weakest in the last five years, the US GDP grew way below the industry expectations of 1.2% for the fourth quarter. Well, the main culprit once again was the tumbling housing sector that further chopped off a sizable 1.2% off GDP last quarter as spending on housing projects witnessed a deep cut of 23.9%, the most since 1981. Even the labour market weakened at 4.9% – a pace that in the past had showed the way to recession. The decline indeed poses a further threat to consumer spending that has already slowed to 2% from 2.8% a quarter earlier. Affirms Jay Bryson, Global Economist at Wachovia, “The perfect blend of a weakening labour market, plunging house prices along with a sharp credit contraction will continue to put pressure on the economy further putting a stop on consumer spending.”
No doubt, the situation is frightening and the policy makers are doing what seem best to them. What else? Go for rate cuts! Since September 2007, the Fed has cut its short-term policy rate by 225 bps to 3% from 5.25% – all to ease the economy. The industry even predicts further cuts as rates are still way above the 1% level in 2003. “We foresee a further rate cut by 25-50 bps by March,” agrees Dean Maki, Chief US Economist with Barclays Capital. Although, the Fed action will boost the liquidity in the economy. But then one should not forget that it was the rally of cuts in interest rates in 2001-03 (the last downturn), that sowed the seeds of the ongoing housing and credit crunch. Well, what about inflation, which is already proving to be double whammy for the economy watch dogs? Fed Chairman Ben Bernanke is already been under criticism for being far too cautious. And if these cuts also prove to be temporary (which of course have a better chance), it would only worsen the situation.
The core personal consumption expenditure deflator (an important indicator of inflation) is already at 2.7% on an annualised basis – the second fastest since 2005. And as such, the threat of stagflation (a situation of both economic sluggishness and rising inflation) has to weigh on the Fed decision before it goes for another rate cut, otherwise it will lose its grip on the economy (or has it already?).
When the US economy sprinted through the third quarter
of FY 2007 at 4.9% (its fastest pace in the last four years), many felt that the worst was over. But, as the US Commerce Department, on January 30, came out with the latest numbers, it only provided further credence to the arguments that the US is knocking on the door of recession, if not already in.Managing just 0.6% growth rate - its weakest in the last five years, the US GDP grew way below the industry expectations of 1.2% for the fourth quarter. Well, the main culprit once again was the tumbling housing sector that further chopped off a sizable 1.2% off GDP last quarter as spending on housing projects witnessed a deep cut of 23.9%, the most since 1981. Even the labour market weakened at 4.9% – a pace that in the past had showed the way to recession. The decline indeed poses a further threat to consumer spending that has already slowed to 2% from 2.8% a quarter earlier. Affirms Jay Bryson, Global Economist at Wachovia, “The perfect blend of a weakening labour market, plunging house prices along with a sharp credit contraction will continue to put pressure on the economy further putting a stop on consumer spending.”
No doubt, the situation is frightening and the policy makers are doing what seem best to them. What else? Go for rate cuts! Since September 2007, the Fed has cut its short-term policy rate by 225 bps to 3% from 5.25% – all to ease the economy. The industry even predicts further cuts as rates are still way above the 1% level in 2003. “We foresee a further rate cut by 25-50 bps by March,” agrees Dean Maki, Chief US Economist with Barclays Capital. Although, the Fed action will boost the liquidity in the economy. But then one should not forget that it was the rally of cuts in interest rates in 2001-03 (the last downturn), that sowed the seeds of the ongoing housing and credit crunch. Well, what about inflation, which is already proving to be double whammy for the economy watch dogs? Fed Chairman Ben Bernanke is already been under criticism for being far too cautious. And if these cuts also prove to be temporary (which of course have a better chance), it would only worsen the situation.
The core personal consumption expenditure deflator (an important indicator of inflation) is already at 2.7% on an annualised basis – the second fastest since 2005. And as such, the threat of stagflation (a situation of both economic sluggishness and rising inflation) has to weigh on the Fed decision before it goes for another rate cut, otherwise it will lose its grip on the economy (or has it already?).
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