Yesterday I wrote on the U.S. economy and the Fed that will have to act someway or the other to at least try to avoid Japanese deflation scenarios. So as I promised, today you could have read the options available to the Fed. Not in my blog, but on the front page of the Wall Street Journal. Surprise!
First of all a word on my new colleagues: they are really great (they must be reading this sooner or later, so if I wanted to say something bad about them, I couldn’t anyway, for my own sake). The first day of my internship at iCC has past and I have to say that I look forward working there and doing the research for my master thesis (and for iCC, as the report is also in their interest), but more on this some other time.
Anyway, I don’t want to disappoint you already after my third blog (this will scare away the few loyal followers) so I will write here what I promised to write; let me quickly summarise what the article said (and which is, of course, exactly what I was going to write J).
So hang on: here is what the Fed could (COULD, not should) do:
1. Ideally, the Fed would strengthen its promise of keeping the fed funds rate low for an extended period of time, in order to encourage investors to borrow and take risks. Forecasts already expect the rate to stay close to zero well into 2011, so if this is not encouraging enough, what is? An yes, there is the problem of credibility. Because once investors borrowed, why not increase the rate?
2. A road the Fed could take is to push short-term rates to zero, but they are very reluctant to do so as it would disrupt the money market.
3. An attractive thing to do would be to use cash received from mortgage-backed securities or underlying loans that are paid off to invest in new mortgage-backed securities. At least, it seems to be an attractive option as it signals the Fed’s attempt to stimulate growth and so avoid deflation. A likely course of action, but the estimated impact is small, as mortgage rates are already very low so further stimulation is unnecessary.
4. Lastly, a very aggressive option would be to repurchase U.S. government bonds or mortgage-backed securities, to push down the long-term interest rate. The only problem here is that also this effect is likely to be small; the Fed would then have an even smaller portfolio to pour money from into the economy. The damage would be huge if the plan would backfire and inflation expectations rise.
So this was the theoretical part. Basically, the hands of the Fed are tightened and there are drawbacks to every option it has. Pumping money into the economy to get people to spend can stimulate growth, but whatever the Fed does, it comes at the cost of further increasing budget deficit and so it further constrains fiscal policy. What is really needed are tools to get employment up, fight falling wages and prices, but this is not the job of the Fed.
Currently the Fed is debating internally about what to do, and I think that is the best they can do; let them sit there and debate, because loosening monetary policy even more will do more harm than good. Let the U.S. government solve out how to fight unemployment and get spending and investment up.
To close with, I want to warn you. Research performed at the University of Chicago shows that loneliness can raise blood pressure. Such a relief: this holds only for those aged above 50. Don’t think: ‘time to start making friends before I’m that old’! First of all: 50 is not that old, I plan on becoming 110. Second, it’s not the amount of friends you have that determine how lonely you feel, but rather how long you can wait before someone write/calls you and how long you can stand to be alone (i.e. feelings of loneliness). Obviously perhaps, but nice that this gets confirmed by research.
