The Economist asks the question that is on everybody's minds, and seems to come to the conclusion that, like the rest of us, on balance they're not sure. Its finger crossing time, but with plenty of downside risk.
So should the Fed have gone further, or will the latest rate cut do the trick? Answering that question is difficult, partly because there is some doubt about the Fed’s main objective in making the reduction. Before the announcement, which came at the end of the Fed’s regularly scheduled meeting, deflation was the word on everybody’s lips. A series of comments from the Fed chairman, Alan Greenspan, and some of his colleagues, had made it clear that the Fed is concerned about the risk of prices falling in the American economy. Economists and financial-market players expected that the Fed would justify any cut as a pre-emptive strike—what Mr Greenspan recently called a “firebreak”.According to its statement, the Fed remains concerned about deflation. It repeated the view expressed after previous recent meetings: that though the risk of a further fall in inflation is small, it is greater than the risk of a resurgence of inflationary pressures. That clearly implies the scope for further reductions in interest rates—and the Fed has taken advantage of that room for manoeuvre. Since inflation is likely to remain subdued for some time, the Fed’s continued emphasis on deflationary risks also implies that low—and possibly even lower—interest rates are likely to be a feature of the American economy for some time.
But the statement implied that concern about deflation was not the principal motive for the latest interest-rate cut. Instead, the main justification offered was the need for a more accommodative monetary policy to give a further stimulus to the economy. On balance, Mr Greenspan and his colleagues seem a little more upbeat about America’s economic prospects now than they did after their last meeting, in May. They noted some of the improvements signalled by recent economic data. But the Fed statement went on to note that the economy has yet to show signs of sustainable growth. Loosening monetary policy still further will, the Fed hopes, give further support to the recovery it believes is under way.
Of course, concerns about deflation and slow growth are closely interlinked. If the American economy were to slide into deflation, with prices actually falling, hopes for a sustained economic recovery would be dashed. Once prices start to fall, consumers and businesses postpone all but the most essential purchases. What is the point of buying something now if it will be cheaper in a few months’ time? It is easy to see how quickly the economy could slide back towards recession. Japan, in or close to recession for much of the past decade, is now experiencing its fourth consecutive year of falling prices. The economy is moribund.
Buoyant growth is one of the best defences against deflation. Persistent economic underperformance is a breeding ground for the economic phenomenon that last plagued industrial countries on a widespread basis in the 1930s. And that is why the Fed remains anxious about the American economy’s failure to gain momentum now. Since the recovery began, at the start of last year, there have been several false dawns. After 18 months or so, the economic signals continue to be mixed. The stockmarkets have become more optimistic lately—though they lost some ground after the Fed’s latest announcement. But business investment has yet to pick up in the way Mr Greenspan has consistently argued is essential for sustained recovery. And unemployment, at 6.1%, is currently at its highest level for nine years.
Source: The Economist