Monetary Policy Challenges

It seems to me….

In principle, there are only three main components of spending that much matter to monetary policy: consumer spending, business investment, and exports and trade.”  ~ Evan Davis[1].

While the global economy still faces numerous challenges, every advanced economy will expand in 2015 for the first time since 2007.  All economies periodically encounter economic downturns: few economies have ever gone as long as a decade without experiencing a recession – the U.S. recovery began in 2009.  As emphasis remains on strengthening economic growth, all nations, including the U.S., remain unprepared for that very likely contingency of an imminent downturn – existing high national debt would discourage stimulus investment, extremely low interest rates would prevent further rate reductions (the liquidity trap)….

The U.S. economy is doing better than at any time in recent years but economists are becoming increasingly pessimistic concerning future increased financial risk.  The Federal Reserve has maintained extremely low interest rates since the financial crisis of 2007-2009 to aid financial recovery.  While that policy has been very successful, with termination of their Qualitative Easement Program (QE2), interest rates will inevitably increase possibly weakening the economy’s overall performance resulting in a possible downturn.

Stock prices are at record highs.  The housing market has largely recovered.  Unemployment is very low.  Consumer spending exceeds pre-recession levels.  Though the national debt continues to increase, all other economic indicators are positive but with no remaining slack in the labor market resulting in likely employee compensation increases and increases in interest rates, price inflation is the normal result which could negatively affect consumer spending.

The low rates have, however, created their own problems: investors are increasingly purchasing longer-term securities paying higher interest rates than other alternative investment options.  When these buyers decide to sell those securities when interest rates, such as for 10-year Treasury Bonds, increase to more traditional yields of around 5 percent from the current 2.2 percent prior to maturity, they will be able to do so only at substantial loss.

Low interest rates have also resulted in a large increase in the issuance of corporate bonds – many of which have been purchased by traditional mutual and exchange-traded funds.  Buyers correctly believe they should have total liquidity in their purchases and are able to redeem those bonds on 24-hour notice.  Unfortunately, when the fund holder is forced to sell those bonds, traditional buyers, commercial banks, might be unable to purchase them as a result of Dodd-Frank banking legislation changes affecting capital requirements resulting in a liquidity-mismatch and sharp decline in bond prices.  Margin debt, the amount of money investors have borrowed on margin, is at a record high indicating stock market over-confidence.

While desirable to initiate economic corrections so as to return to more normal conditions, raising interest rates while wages are flat and inflation remains well below desired levels risks pushing the economy back into deflation and precipitating the recession everyone is attempting to avoid.  It is best to wait until wage growth is entrenched and inflation is at least back to its target level[2].  Inflation slightly too high is much less dangerous for an economy than premature rate increases.

With a robust economy, it is best to slowly increase taxes and reduce expenditures in order to lower the current national debt.  Present low interest rates, though currently manageable, inflate asset prices and create long-run financial risks.  Little has been done to improve national infrastructure which remains desperately in need of improvement and repair and also would strengthen employment growth.  Growth always is better than austerity as a policy for bringing debts under control.

Increasing Federal interest rates and returning to more normal rate levels is necessary but doing so without destabilizing the economy will be difficult.  Increased government spending will be necessary to maintain current GDP growth but with current and anticipated national debt increases, this will be difficult to sell to conservative members of Congress.  Decreases in defense and other non-discretionary spending categories are insufficient to prevent national debt increases.  Tax code revision eliminating a wide range of individual and business subsidies is required but members of Congress are always reluctant to eliminate any subsidy beneficial to contributors or lobbyists.  Voters might elect our representatives but it is economic interests that in reality control our government.

That’s what I think, what about you?

[1] Evan Harold Davis is an English economist, journalist, and presenter for the BBC.

[2] Watch Out, The Economist, http://www.economist.com/news/leaders/21654053-it-only-matter-time-next-recession-strikes-rich-world-not-ready-watch?fsrc=nlw|hig|11-06-2015|NA, 13 June 2015.

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About lewbornmann

Lewis J. Bornmann has his doctorate in Computer Science. He became a volunteer for the American Red Cross following his retirement from teaching Computer Science, Mathematics, and Information Systems, at Mesa State College in Grand Junction, CO. He previously was on the staff at the University of Wisconsin-Madison campus, Stanford University, and several other universities. Dr. Bornmann has provided emergency assistance in areas devastated by hurricanes, floods, and wildfires. He has responded to emergencies on local Disaster Action Teams (DAT), assisted with Services to Armed Forces (SAF), and taught Disaster Services classes and Health & Safety classes. He and his wife, Barb, are certified operators of the American Red Cross Emergency Communications Response Vehicle (ECRV), a self-contained unit capable of providing satellite-based communications and technology-related assistance at disaster sites. He served on the governing board of a large international professional organization (ACM), was chair of a committee overseeing several hundred worldwide volunteer chapters, helped organize large international conferences, served on numerous technical committees, and presented technical papers at numerous symposiums and conferences. He has numerous Who’s Who citations for his technical and professional contributions and many years of management experience with major corporations including General Electric, Boeing, and as an independent contractor. He was a principal contributor on numerous large technology-related development projects, including having written the Systems Concepts for NASA’s largest supercomputing system at the Ames Research Center in Silicon Valley. With over 40 years of experience in scientific and commercial computer systems management and development, he worked on a wide variety of computer-related systems from small single embedded microprocessor based applications to some of the largest distributed heterogeneous supercomputing systems ever planned.
This entry was posted in Assets, Austerity, Banks, Bonds, Debt, Dodd-Frank, Downturn, Economy, Federal Reserve, Financial, GDP, Housing, Inflation, Infrastructure, Interest, Investment, Investor, Labor, Liquidity, Lobbyist, QE2, Qualitative Easement, Recovery, Securities, Spending, Stimulus, Stocks, subsidy, Tax Code, Treasury, Wages, Yield and tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Bookmark the permalink.

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