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Generational Dynamics Web Log for 9-Aug-04
The world awaits Fed's interest decision on Tuesday

Web Log - August, 2004

The world awaits Fed's interest decision on Tuesday

The Fed should leave interest rates unchanged, since we're in a long term deflationary period.

If you forget the political passions of the moment, and look at the historic long-term trends, then the economy has plenty of built-in pressure to move in a deflationary direction. That means that the Fed has a lot less to worry about with respect to inflation than many analysts believe.

On the other hand, Friday's bad jobs report shows that the economy's labor market is in much worse shape than high-priced analysts have been saying for months. The fact is that analysts are stumped - they did not see this coming and they have no explanation for it except, "well, it's just a bump in the road." But it's now a three-month bump, and no one that I've heard is really certain that things will be better next month. In fact, let's face it: It's been years since the high-priced analysts have gotten their labor and output forecasts right.

What's going on in the economy has been fully explained on this web site.

And this brings us back to the question: What is the Fed's best policy now? Should the Fed increase the overnight funds rate to 1.50% from 1.25% tomorrow, as many people expect?

No matter what we think of the Fed's zero-interest rate policy since 2000, it's saved the country from an economic disaster, or at least postponed it. If the Fed had kept interest rates up, there's little doubt that we would have already had a cascading stock market crash like the early 1930s, with massive bankruptcies and homelessness.

If the Fed increases interest rates too much today, the effects will actually be much worse than they would have been in 2000. That's because many more people are in debt today than in 2000, so there would be many more bankruptcies and foreclosures.

The Fed should keep interest rates steady for now, and permit a little more inflation if necessary. An additional weakening of the dollar on international markets will not be that harmful either. The Fed can't continue this policy forever, of course, but there are so many uncertainties in the world today that it won't be long before something happens (a war, or collapse of the Chinese bubble, for example) to force a change of policy.

If a major economic upheaval has to occur, then let it happen because of some major international event, not because the Fed precipitated it. (9-Aug-04) Permanent Link
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Generational Dynamics Web Log for 9-Aug-04 The world awaits Fed's interest decision on Tuesday

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Generational Dynamics Web Log for 9-Aug-04
The world awaits Fed's interest decision on Tuesday