Economic Commentaries

13

Beginning January 21, 2017 there shall no longer be gnashing of teeth over political gridlock. With republicans gaining control of the legislature and the presidency, reform legislation should be crafted and enacted into law fairly smoothly and quickly ( within six months). There will no linger be any excuse for inaction. In our view policy prescriptions for addressing weak and uneven economic growth should be a top priority. This will involve tax reform and simplification and a roll-back of overbearing regulation. Trade and immigration reform should be part of an economic agenda but in the short term these could be divisive and distracting.

The new administration will assume office in an era of sclerotic global growth and also a structurally rising public sector deficit. However, if the economy's growth rate could be raised secularly from 2% to 3% and ideally 4%, the country would be on a path to gain control over the deficit and debt. To do so, private sector risk taking needs to be encouraged and the credit creation process needs to be unleashed.

Near term three things will be front and center in our view. Markets and governments worldwide will carefully scrutinize forthcoming appointments to key economic posts such as Treasury, economic advisory positions, and trade representatives. Markets will also watch for any threats to the independence of the Federal Reserve. Assuming any post election market volatility is brief, the election should not be a deterrent to near term action by the FOMC. We do not think a rate rise in December is necessarily warranted, but the FOMC is desirous of moving toward rate normalization. In any event we would expect any rate move to be accompanied by soothing and cautious language about policy in 2017.

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Posted in: General
13

Speakers at the Federal Reserve's annual Jackson Hole Wyo. conference seemed to talk past each other. One group expressed concern that the U.S. and global economy is in the late stage of economic expansion and inflation and growth are still intolerably low and slow. Indeed, soundings from the BOJ and ECB were in the direction of more accommodation. Others focused on unconventional policies in the U.S. in the event of a downturn, including negative interest rates; a boost to the 2% inflation target; a permanent increase in the balance sheet; targeting nominal GDP.

Of these we think negative interest rates and a boost to the inflation target are the least attractive. Targeting nominal GDP is worth consideration. But ideally this should require joint monetary and fiscal action. Unfortunately this is very likely beyond the ability of policymakers to implement in a vacuum, but fiscal expansion with central bank debt monetization is within the scope of policy coordination.

Meanwhile, in her keynote address Fed Chair Yellen rejected these extraordinary actions, suggesting that the Fed still has sufficient conventional tools to combat recession. Indeed she suggested that even these may not be needed anytime soon because the domestic business outlook is improving. In this vein the Fed Chair suggested that steps toward interest rate monetization could be taken in coming months.

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Posted in: General
08

G-20 finance ministers met last week with little fanfare and little accomplishment. The ministerial communiqué alluded to a growing ineffectiveness of monetary policy while tilting toward the need for coordinated fiscal policy. China was the host country and it intimated that it would boost fiscal spending. Otherwise there was no joint action plan. Finally, G-20 denounced competitive devaluation as a means of boosting exports and growth.

For most countries fiscal policy will remain in a straitjacket near term so monetary policy will still be in focus. With deflation accelerating in Europe the central bank is likely to ease further. With anemic growth in the U.S. and the dollar remaining strong the Federal Reserve is likely to ease by deferring an interest rate increase while modifying its timetable for future increases.

In the current quarter U.S. real GDP growth appears to be running at a 1.5%-2% annual rate as consumption and construction benefit from favorable fundamentals and good weather. But inventories and trade will be drags and business investment remains anemic. Some activity may be being stolen from the spring as well so we have little expectation for any acceleration.

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Posted in: General
05

As the old year ended and a new one begins, the economy and financial markets grapple with three basic domestic issues. These are prospects for fiscal policy; the machinations of voter preferences for the next President; and the Federal Reserve's policy prescription as it affects economic growth and interest rates. None of these seem favorable.

On fiscal policy a compromise omnibus spending bill was passed late last year, avoiding any near term government shutdown. But in doing so lawmakers offered a modicum of fiscal stimulus by agreeing to abandon the sequester caps imposed by the 2011 Budget Control Act. So much for fiscal discipline while nothing was accomplished on the important issues of tax and regulatory reform that might actually aid economic growth.

On the political front it hardly seems likely that tax and regulatory issues will be addressed this year. Indeed, on the democratic side if anything candidates are promising more taxes and more regulation. The republican field remains wide open with fringe candidates exhibiting considerable staying power. Republicans might address tax and regulatory reform in a new administration but concerns over governance could be unnerving.

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Posted in: General
24

With so much attention being directed at this coming week's FOMC policy meeting, we think a few underlying considerations should be kept in mind. These reflect themes we have repeatedly enunciated.

The Federal Reserve has made it very clear that it wants to raise short term interest rates and begin some sort of glide path toward a normalized interest rate environment. Proponents of this desire use two basic arguments. One is that the Fed needs to raise rates so that it would have room to ease in the event of an economic downturn. A second is that with uninterrupted economic growth for the past several years and the jobless rate having declined significantly, there is no longer an economic emergency and thus no need for an emergency interest rate.

A move toward policy would have been facilitated long ago if fiscal and regulatory policies had been growth oriented, but unfortunately this has not been the case. Thus, an emergency rate has been necessary. Nonetheless, raising rates now so they can be cut later if necessary is like banging one's head against a wall to see if it hurts.

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Posted in: General
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