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.
