The US economic outlook is worsening, as evidenced by preliminary GDP numbers for Q1, 2015; even this month’s Eurozone numbers were better. The rise of the US dollar, though seeming to herald an imminent raising of interest rates, in fact has generated lower import prices while raising the price of exports. In addition to other disappointing indicators, the earlier increase in US consumer spending has almost broken down entirely; and instead of finally tightening monetary policy, the US Federal Reserve must now begin to consider fiscal accommodation to preempt a possible recession before it begins to think about adjusting policy upwards.
Unpinning the Hinge
Returning to the age of quantitative easing or lowering interest rates may not be such a bad idea, especially since expanding balance sheets require immediate and out-of-the-boxconsideration. What is certain is that a rate hike at a moment characterized by minimal growth and weak inflation will most probably strengthen the ropes holding the economy down – especially considering that monetary policy resonates on a global level… Europe being the prime example.
The temptation to label the Eurozone’s recovery as temporary, no more than momentary gains resulting from interest rates at or below zero-level, should be resisted, especially with the European Central Bank claiming that these have prevented a deflationary disaster. Moreover, the fundamentals seem to support European claims… at least for now. The question remains, what do Eurozone leaders – as opposed to their American counterparts – have planned for the day after?
For, rather than financing fiscal stimulus with cheap borrowing rates, governments have so far chosen to cut budgets and promote austerity. Remove the easing and accommodating policies, and the lack of a continued fiscal policy becomes clearly evident.
To Ease or Not to Ease
If the US Fed expects to maintain a competitive economy, it may be forced to reinstate quantitative easing – especially considering the unconventional policies being employed by its global peers. The US will almost certainly be sucked into the ongoing global currency war due to sinking fundamentals. Notwithstanding its toxic influence on investment, an unconventional approach towards fiscal policy often leads towards increased investment in high-risk, otherwise unviable projects – shale oil being an excellent case-in-point. Because of big-ticket technologies, expensive development and high breakeven points, cheap (pre oil glut) money led to the development of this highly promising energy alternative and others.
Clearly, the currency devaluation that stems from quantitative easing is also an excellent tool to encourage global trade. Unfortunately, the downturn exposes the danger of misdirected investment. Moreover, even though the increased printing of money has not led to hyper-inflation, each bill printed contributes less than the last to augmenting economic momentum – a form of diminishing marginal returns, which is harmful – especially to struggling economies.
To Have but Have Not
The US Federal Reserve thus finds itself in between a rock of credibility and a hard place of prudence. Having all but promised to raise interest rates this year, the Central Bank stands to jeopardize its integrity by going back on its word; however the numbers insist upon stronger monetary measures – perhaps concomitantly somehow maintaining a dovish policy. If indeed the economy enters a recession, the Fed would be well advised to raise interest rates nominally by – perhaps – 5 basis points, then cut them back down and resume quantitative easing thereafter. Either way, it is clear that US economic expansion has hit a snag that may become turn and contract, becoming a major sink-hole,unless immediate and drastic action prevails.