QUERETARO, Mexico, Dec. 10 (UPI) -- This was the tersest of terse U.S. Federal Reserve communiqués: a minimalist effort that aims to reassure.
The Fed's statement Tuesday afternoon after its committee meeting on monetary policy pointed out no more than that interest rates were "accommodative," productivity growth is "still robust" and data since the November meeting "are not inconsistent with the economy working its way through its current soft spot." And that was it. Therefore the short-term interest rate, the Fed funds rate, stays where it is, at 1.25 percent, a 41-year low.
The Fed can find evidence to support its "soft spot" line. The economic data is mixed. Service industries keep expanding output. Industrial output has been falling, but the Richmond Fed found in November that new industrial orders in its district rose. Ray Owens, an economist in the Richmond Fed, thought Tuesday that this might be "a turning point." The New York-based Conference Board found in November that consumer confidence had rallied, ending five months of falls, with its index climbing to 84.1 from 79.6 in October. The stock market has rallied after dropping in September to five-year lows.
Perhaps this period in neutral can end with the economy finding a supportive wind in 2003 and gradually picking up momentum. That, certainly, is the consensus Wall Street view; and by echoing it Tuesday, the Fed statement helped to reassure the stock market, and the Dow ended the day up 100 points, or 1.2 percent.
Yet the risks that "the soft spot" will persist long beyond the time that this expression will be considered suitable are also high.
The world's central bankers, among whom Fed Chairman Alan Greenspan is the crown prince, have steered their economies into unhappy and dangerous waters. These helmsmen of monetary policy are now, because of their (in some cases new-found) freedom from political pressures, supposed to steer a steady course. But from Japan to the United States via Britain and the eurozone, economic performance is either poor or mixed and there is well-justified dissatisfaction with monetary policy.
In Japan, before its central bank was independent, a real estate and stock market bubble was allowed to build in the 1980s. It burst and, more than a decade on, the stock market is now worth a quarter of its peak value. Monetary policy should have been looser, some economists argue, soon after the bubble burst. But a short-term interest rate of no more than 0.5 percent for many years has not got the economy going.
In the eurozone, interest rates must be set to suit 12 different economies with widely differing inflation and growth. No wonder the independent European Central Bank president, Wim Duisenberg, finds his job difficult. The European interest rate of 3.25 percent is probably too high for Europe's sleeping giant, Germany, and yet it is a negative rate, in real terms, in Ireland, Spain and Portugal where inflation equals or exceeds 4 percent.
In Britain the Bank of England, made independent in 1997 by Chancellor Gordon Brown as soon as the Labor Party won power, reacted quickly, and perhaps hastily, in 2001 to the risks posed to British growth by a slowing U.S. economy, cutting interest rates seven times in the space of nine months. British house prices, always sensitive to interest rates, have soared. Now the bank itself is among those warning of a possible collapse in house prices.
John Butler, U.K. economist at HSBC investment bank in London, says that over 11 percent of consumer spending in Britain is currently being financed by borrowing, including equity extracted from mortgage refinancing. The spending boom, he says, is reminiscent of the one that occurred in the late 1980s -- when the Bank of England was not independent and was under the control of the then U.K. chancellor, Nigel Lawson. The level of debt-financed spending is not sustainable, Butler says, and "raises the risk of an aggressive and sustained slowdown in consumer spending." Fifteen years on from a previous error that left Britain with tumbling house prices and recession and low growth for years, monetary policy in Britain may again have steered the economy toward a long period in the doldrums.
And what about the United States? Greenspan warned famously about "irrational exuberance" in stocks in December 1996 but certainly did not contain this exuberance, which climaxed in 1998 and 1999. It was late in the second half of 1998 that Greenspan cut interest rates three times in response to threats to U.S. economic growth from Russia's default on debt, Brazil's economic crisis and the collapse of a hedge fund, Long Term Capital Management. Until 2001, most observers considered these cuts a masterstroke. Growth had been kept high. Greenspan's monetary management was widely hailed as brilliant. But in the past two years he has been slashing interest rates without being able to lift the U.S. economy decisively.
What has gone wrong?
In Europe, Duisenberg still refers to his maximum inflation target of 2 percent and his broad monetary growth target of 4.5 percent --- both of which are currently being exceeded --- when he announces interest rate policy. He and Europe continue to be guided by benchmarks, even if the benchmarks are not being held to strictly.
Britain and the United States, meanwhile, have responded to threats to growth with alacrity and less concern for either inflation or the monetary growth numbers. The danger in Britain is that falling house prices may now dog the consumer for years. In the United States, too, the housing boom may leave consumers with more debt than value in their homes. U.S. monetary policy, meanwhile, does appear to be pushing on a string, in the words of economist John Maynard Keynes.
"People are queuing up to start criticizing inflation targeting but it's the economies that either did not have an explicit inflation target, such as the United States, or have taken their eye off the one they had, such as Britain, that have created asset price bubbles and look the most vulnerable now," says HSBC's Butler.
What some of the central bankers appear to have forgotten are the limits to growth. The United States has had a very high trade deficit and very low private savings rate for years and has experienced bouts of high inflation -- in stock and, now, house prices. These should be a central bank's concern. Greenspan has tended to ignore the signs of excess while focusing on productivity and on the need to keep growth high.
Duisenberg has a point when he says that not all the obstacles to growth can be resolved by reducing interest rates still further. And problems may be caused by so doing. With a burst stock market bubble to weigh it down and a house price bubble blowing up and about to burst, the U.S. economy may have low interest rates and yet low growth for years to come.
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