The U.S. economy and the Fed

As a skip tonight’s news broadcast (just came back from a board meeting) and still have some time before I hit the bed but it’s too late to engage in some physical activity like my favourite dance game with the Wii, let me share with you my view on the U.S. economy. (That’s having your priorities straight.)

My curiosity on this topic was triggered by Paul Krugman’s blog on the Feckless Fed (btw. feckless means something like not fit to assume responsibility or being generally incompetent – nice word huh?). Paul Krugman is obviously pessimistic on the U.S. economy (rightly so), but moreover he is sceptical on how the U.S. Federal Reserve responds to the situation in the U.S., e.g. high unemployment rates, a huge government debt, too costly reform of the health system and already slow growth.

The first question that came to my mind was how it can be that the IMF in the world economic outlook predicts a growth rate for the U.S. of 3.3% in 2010 and 2.9% in 2011, while the prospects look so bleak. Of course, the states are recovering from the nadir and restoring from such a low does not require much. On the other hand, the fundamentals are really flawed and not much have been done to restore the financial system. The only good news in the last few weeks came from rallying stock indices and releases of macro-economic figures that were not too bad. However, these good figures and the following rallies again stem from increasing imbalances; too high borrowing from emerging economies and future generations. All in all, can we really believe these positive growth projections? I think we should be much more careful than taking these figures at face value.

The second question that came to my mind was when the Fed will make its move to avoid Japanese-style deflation and what move this will be. Paul Krugman’s worries about deflation are not completely ungrounded (and if they were, I wouldn’t dare to say so) and the Fed too has to confess that deflation in the near future is not completely unlikely to occur. So far, they have not taken any concrete action to do so. Even worse, the last statement of the Federal Open Market Committee suggests that economic prospects and the labour market start to improve gradually, but where does this recovery come from? There is only modest income growth and the housing market is still locked due to high unemployment. Okay, business spending is increasing, but confidence is decreasing, and many banks have not yet recognised their losses on commercial mortgage backed securities. The Eurozone economy does also not contribute positively to U.S. growth. These are the reasons for deflation not being completely unlikely.

If the Fed does not recognise this, surely they will not do anything to avoid deflation. If they would recognise it, what can they do? I range the options from hardly credible to somewhat more credible:

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2. 2. ...

But this you can read tomorrow! J Sleep tight.