Monday February 5th was the first day on the job for Jerome Powell as the new FOMC chair. He was greeted with a near 1,000 point drop in the Dow Jones Industrial Average, approximately a 3.9% decline. This was on the heels of a 540+ point drop on February 2nd (a 2.1% decline) and was followed by another 1,000+ point drop (a 4.2% decline) on February 8th. These changes put the Dow (and S&P 500) in “correction” territory, meaning a fall of 10% or more from recent highs. As of now, the Dow and S&P 500 are both still down nearly 7.5% from all-time highs.
The reason for the recent correction could be one of (or a combination of) several factors, including a risky volatility product, a fear of faster wage and job growth than expected, or that recently passed tax cuts might work as expected and result in an overheated economy. Some even believe that the tax cuts and spending increases might result in a “hard landing” for the economy.
As some evidence for the “hard landing”, it appears that interest rates are rising faster than expected as the easy money era comes to an end. This is all reminiscent of the “taper tantrum” of 2013, when the Fed was “winding down” asset purchases. The market did not react kindly to the slow down (and ultimate end) of quantitative easing. Ultimately though, the economy was able to withstand the slowdown of asset purchases without experiencing a recession.
The final point to consider is the relationship between the economy and the stock market. The two are simply different things. Equity markets are a measure of a portion of the expectations of the overall economy.
Questions you might want to consider
- Focusing on the economic reasons for the recent correction, do you believe that the central bank will raise rates faster than they might have previously considered doing? Are we at risk for a “hard landing”? Has the Fed offered any insight on this since Powell took over?
- Inflation in the US has largely lagged behind the medium-term goals of the Federal Reserve. Ultimately though, the goals of quantitative easing might have been to inflate asset prices, rather than goods prices. Consider the difference between asset price and goods price inflation. Is there a greater purpose to stoking some asset price inflation? Examine the role of the Fed in rescuing the banking system in 2008-2009.
- While interest rates spiked during the “taper tantrum” in 2013, the economy remained on a relatively even keel. This time might be different. Do you believe the economy is really as healthy as we say it is? I encourage you to look back at some indicators in late 2007, or early 2008 for help. The last recession began in 12/07, well before the financial markets collapsed in 2008. What do real time indicators say?
- Write your thoughts on anything here that relates to the Fed, asset prices, goods prices, interest rates, Fed politics, Fed policy, and new or old policy. Do not try to cover all topics.
29 thoughts on “ECON430-Topic #2: "Mr. Powell, Welcome to your new desk!"”
It was stated, “The economy is closing in on its ninth year of expansion and it’s expected to keep chugging along in President Trump’s second year in office” (1). Although this idea of a “hard landing” is floating in the air based on Trumps extreme stimulation of the economy, all involved parties are keeping such a close eye on the economy’s levels versus the stock market levels, that it’s nowhere near a possibility. Especially with the new FOMC chair taking charge, this close-watching eye is confidently praying these stock market downturns do not end up reversing the economy’s elevated consumer confidence, business confidence, and low unemployment. The Fed is ready to take precautionary actions, such as increasing the interest rates, in order to avoid stocks falling into a “bear market” territory of 20% below recent peaks (2). Therefore, this stock market episode is just some turbulence that must be worked through: “While a deeper and more persistent drop in equity markets could dash confidence and lead to a pullback in risk-taking and spending, the movements we have seen are far away from this scenario” (3). Ultimately, inflation should increase in the near future, “but not a rate that requires a faster Fed reaction as it gradually rises to the central bank’s two percent target” (3).
You make good points. I think the recent spikes in the stock market are a sign that investors are preparing for a faster rate of expansion and want to invest in equity. Like you said, “…this stock market episode is just some turbulence that must be worked through…”. The recent correction could be a consequence of excited investors jumping the proverbial gun before the policy changes take full effect.
The stock market was bound to have a correction with the constant rise in prices we have seen in recent years. “It’s rare that stocks go for nine years without a correction, which is a decline of 10% or more” (forbes.com). A possible reason for the correction could be the signaling from the Fed that interest rates will rise sometime later this year. When interest rates are favorable, investors can sell-off their stock and put their money into safer bonds, which guarantee a return. The sell-off of stocks to obtain a safer return would cause the price to fall. Additionally, the US cut taxes in a time where there was not a serious threat of an economic downturn. This coupled with preexisting low interest rates from 2008 and a low unemployment rate could have stimulated or overheated the economy to the point where inflation is likely. According to Gapen “inflation picks up as a result of increased consumer spending, spurring the Federal Reserve to raise interest rates more quickly than expected by markets” (finance.yahoo.com). I think this is a logical conclusion to draw and if the economy continues to grow above a sustainable rate than inflation will increase. This perhaps will force the Fed to raise rates higher than previously signaled. When interest rates go up faster than anticipated by markets this can lead to an economic downturn after a surge, or a “hard landing.”
Looking back to the Great Recession of 2007-2008, there are many current economic indications that imply that the economy is on track for another recession. Before the recession of 2001 and the Great Recession, the Effective Federal Funds Rate was steadily increased from 4.63% in January of 1999 to around 6.5% in late 2000, and from 1% in 2004 to 5.25% in 2007 (1). More recently, the Fed has begun targeting increases in the FFR again, starting at 0.12% in November of 2015 to its current rate of 1.41% in January of 2018 (1). The slow but steady increase in Federal interest rates is due to worries of increasing inflation rates during economic recovery (2). The continuous decrease in the unemployment level, from the peak of 10% unemployment in October of 2009 to 4.1% in January of 2018, seem to positively impact the everyday American, but are starkly reminiscent of the falling unemployment rates prior to 2001 (from 7.8% in 1992 to 3.9% in December of 2000) and 2007-2008 (from 6.3% in 2003 to 4.4% in 2007) (3, 4). Although they are not directly related, the unemployment rate and the Federal Funds Rate seem to have an inverse relationship: decreasing unemployment rates signal a temporarily-strengthening economy, which the Fed responds to by aiming to increase interest rates to prevent “overheating” [to see for yourself, graph the Civilian Unemployment Rate with the Effective Federal Funds Rate on FRED] (2, 5). This combination of indications illustrates the path towards an economic recession, as depicted by the previous two downturns, and there is reason to believe we are heading down that pathway once again.
I believe that the Fed will raise the interest rate soon. When Janet Yellen was in the office, she was in sync with the idea of keeping low interest rates. (1) Low interest rates mean lower costs for borrowing. (2) Consumers and businesses have more incentive to borrow money to make big purchases. (2) As the result, keeping interest rates low can boost spending, output, and productivities. On the other hand, low interest rates contribute to the rise of debts levels and assets prices. (3, 4) They are debt-funded assets, so they can create bubbles, therefore, create the next financial crisis. (4) When debts levels are high, lenders lose faith in borrowers and stop lending. (3) Thus, I think that the Fed will raise the interest rate (Federal Fund Rate), but they won’t increase it too much. Trumps picked Jerome H. Powell as the chairman of the Federal Reserve because they are both in sync with the idea of raising interest rates. (5) “Raising interest rates is typically aimed at fighting inflation” because “inflation remains at or below the Fed’s targets”. (Jeff Stein, 5) Additionally, high interest rates can attract more foreign investors as they seek for higher returns. (6) However, if the interest rates are too high, people and businesses will have less incentives to make purchases. (2) Moreover, high interest rates mean that the U.S. dollar will appreciate against its trading partners, making U.S. goods more expensive to foreigners. (7) I believe that the interest rates won’t increase too much because a big increase in the interest rates may cause spending, outputs, activities and net exports to decrease. I think the Fed will increase Federal Fund Rate by only 0.25% to 0.5%.
Although I do not believe the country will fall into a recession, there are some signs that point to its possibility. The stock prices are an indicator for the leading index, so the steep fall in the S&P 500 brings the possibility that the economy is on track to weaken. This stock price drop correlates to another indicator, consumer expectations. With the falling prices, it is likely that consumers will begin to worry about the future state of the economy and react accordingly. However, there are more indications that the economy will continue to grow. The leading economic index has increased in twelve of the last 13 months. To draw parallels with the Great Recession, the index dropped several times throughout 2007 before dropping sharply during the month of the recession. The leading index has a problem with overpredicting recessions, but they do not tend to predicate growth when the economy is contracting. Twelve months of a leading index increase is a good sign. Also, in almost every month that the leading index fell in 2007, stock prices were a positive contributor to the index. Clearly, stock prices are not a very good indicator for how the economy is doing, or how it may do in the future. It seems like the best indicator for the success of the economy is the claims for unemployment insurance, which was a negative contributor every time the index fell in 2007. With the unemployment rate staying the same over the last several months, it is likely that the economy will continue to grow.
Your analysis on possible expectations of predicting a recession was good. While I agree that I do not believe that the country is going into a recession, there could be some comparisons drawn between the US Leading Economic indicators provided by the Conference Board during September 2007 financial crisis. In 2007, all three types of economic indicators (leading, coincident, and lagging) increased. In my opinion, focusing on these types of indicators and what trends within the specific indexes are important in forecasting a possible crisis.
The worries of an inflation spike causing a recessionary rise in interest rates that in part caused the recent stock market volatility are unlikely to be actualized. It first should be noted that wages did not increase by 2.9% in January from December; they increased by 0.3% from December (1). The 2.9% increase was wage growth on the year from last January. Although the 0.3% increase is higher than the month on month average over the past two years, the increase in wages from last November to last December was higher at 0.4%. That market correction came after the January numbers were released rather than after the December numbers were released, and that the 2.9% figure is the one commonly reported, suggests that the implied anxieties of traders and pessimistic predictions in the media are founded upon imprecise interpretations of data, and are better indicators of animal spirits than an impending recession.
Also, a significant neglected determinant of whether the increase economic growth is expansionary and inflationary or real is productivity growth. Given a constant markup of prices in goods markets over those in the input markets, increases in costs of production cause increases in prices (2). Costs of production are a positive function of wages, but a negative function of productivity, so whether the wage increases are inflationary or real depends on productivity. According to the BLS, productivity increased by 1.2% in 2017, and wages grew by 2.9% from last January, giving a difference of wages growing 1.7% faster than productivity in 2017 (3). The average of this difference from 2011-2016 was around 1.57%, so the most recent wages increases are not particularly less supported by productivity gains than the historical wage increases in the post-recovery expansion (using sources 2 and 3). It is possible that recent fiscal policy will lead to inflationary stimulation, but with a 12-month core inflation rate from last January to this January lower than that from January 2016-2017 (1.8% vs. 2.3%), the need for contractionary monetary policy has not yet materialized.
The stock market’s recent plunge into a correction period has been explained by recent surges in the economy such as the unemployment rate falling and real wage rates rising. Many believe this is partly due to Trump’s tax cuts (1). If this means the Fed must raise the federal funds rate to thwart overheating, then so be it. Since the recession, the FFR, and ultimately economy-wide interest rates, have been historically low (2). This was necessary to stimulate economic activity but it does not necessarily describe a healthy, historical equilibrium. If interest rates go up, it may hurt borrowers, but it could help lenders and holders of bonds as yields go up as well as savers and those who invest in money market accounts. Alternatively, if the Fed does not raise rates and allows the potential increase of inflation, this too may only serve to fit nicely with their goal for 2% inflation rates in the medium term that has not quite come to pass (3). In fact, since the Obama administration and the Fed’s policies to the recession, many have incorrectly expected rapidly rising interest rates when in reality “secular stagnation” has been more of a problem post-recession (4). Finally, a possible interpretation of the recent decline in the stock market is merely a correction of animal spirits in Trump’s election and tax cuts, but the economy is not seeing some sort of massive implosion. However the Fed decides to react, the economy may in fact be going to a more stable state that reflects historical expansionary periods.
Janet Yellen just recently completed her term as Chairman of the Fed. Jerome Powell took over the position and is said to be on the same page with approaching higher interest rates cautiously (1). Nevertheless, with the recent tax cut that the economy has experienced, rates could increase faster than the market expects. This is because with the combination of a tax cut and an increase in spending, it could lead to the economy having a ‘hard landing’ (2). A hard landing refers to a marked economic slowdown or downturn following a period of rapid growth (3). Economist Gapen states, “We believe that tax cuts will stimulate household spending faster than business investment can improve productivity and, as a result, some of the output growth in our forecast will be accomplished through additional hiring (2).” As a result of this, inflation would increase because spending increased. This would encourage the Fed to raise interest rates quicker than expected, which could make credit conditions tighten, leading to an economic downturn (2). The tax cut made consumers happy because to the normal eye, tax cut means more money for consumers to either save or spend. On the other hand, if one is an economist or someone who follows the stock market, the tax cut is not all smiles and cheers. It could lead to an overheated economy described above.
“Policymakers, academics, and other informed observers” (1) all agree that it should not be in the capacity of the government or politics to influence the Fed, making the government and the Fed two completely distinct entities, furthering the division between the stock market and economy, as well. However, the government is not the only body powerful enough to influence the Fed. As cited by President Trump in the State of the Union address, a recent “spike in wage growth” after “years of wage stagnation” (2), is something that may have served to boost his popularity among the public, but wage growth is something that actually worries Wall Street that it “will lead the Federal Reserve to raise interest rates more quickly… as those pay increases spur stronger inflation” (3)(4). The Federal Reserve maintains a dual mandate of full employment and stable prices, “but there’s an unwritten third mandate: financial stability. And that’s led the Fed to alter its plans in the past” (5). Although the government and Fed are legally prohibited to mix politics and decision-making, there is something to be said for the volatility of the stock market and how this has the power to sway the decisions of the Fed, and the Fed’s ability to impact both the stock market and economy at once. This being said, politics, whether it comes in the form of a tweet, a nomination, a State of the Union address, investor pressure, or a generally uneducated public that relies on the notion that the stock market is equivalent to the state of the US economy, has a hard time not influencing Fed decisions, and in a world that becomes more connected each day, Jerome Powell has his work cut out for him in keeping the Federal Reserve its own independent decision-making entity.
Jerome Powell faced the stock marker’s “biggest stock meltdown in the last six years” with the DOW going down 1,175 points (4.6%) on his first day of being the new chairman of the Federal Reserve (1). This is apparently not a rare occurrence with new Fed chairmen starting out, as described by Ryan Detrick, a senior market strategist for LPL Financial, who says that it is normal for there to be “weakness after a new Fed chair” (2). When Janet Yellen took office in February 3rd 2014, the Dow Jones had went down by 326 points (2.1%) (3). Both new Fed chairs faced some sort of drop in the stock market when they first started however there were different reasons for those drops. In February 3rd 2014, it was suggested that “bad data” was the cause of the crash because of poor forecasting and earnings. However with the case of the Dow Jones drop in early February 2018, it has been suggested that cause is more related to anticipation of the Fed rising interest rates to combat inflation (meaning stock prices would most likely fall and as well as corporate profits) after Trump’s corporate tax cut and a correction to the unsustainable stock market rise which, if continued, could create a bubble. Even though it was said that Jerome Powell is the second to Eugene Meyer, Fed chair of 1930 to 1933, as the “worst Fed Chair in regards to the Dow Jones performance”, it seems as if though the February 2018 Dow Jones correction was mostly due to Trumps corporate tax rate cut which boosted corporation’s profits to an unstainable level rather than Jerome Powell’s first day as Fed Chair(2).
I would argue that the economy is decently healthy and a recession is not looming in the near term. New housing construction continues to rise at a steady pace, wage growth is picking up after a long time, and inflation is hovering around two percent. None of these indicators are at historically high values signaling that the economy is not necessarily at its peak. While the wage growth and inflation will most likely lead Jerome Powell to tighten monetary policy, most would agree that the United States federal funds rate is still not restrictive and maybe even accommodating. While I agree the neutral rate may be decreasing, the Federal Funds rate is nowhere near the five or six percent rate that was present before the last two recessions in 2000 and 2007. Furthermore, the stock market has already priced in at least two rate hikes in 2018 with a fifty percent chance of three rate hikes. Wage growth and inflation is not at such a level where we would see four rate increases this year. Also, the stock market correction could actually be a good sign for the short run prospects of the economy. In January the stock market reached exuberantly high multiplies even when accounting for increase in corporate earnings. The correction may have been vital to keeping the market from entering bubbly territory. During the market correction, high yield bond yields did not rise by levels that would be consistent with a major risk off attitude. Normally a major risk-off attitude is the method by which asset values fall in such a way that dampens the entire economy. While high multiples and increasing interest rates may lead the United States economy into a recession, there is not enough evidence to conclude a recession is coming yet.
All additional data pulled from the FRED database
With the recent sell-off in the stock market, concerns are rising that the economy may not be ready for the Fed’s planned increases in the FFR. The recent decline in the Dow Jones is simply marking an end to the era of near-zero interest rates, and is not a reason to panic. Jerome Powell has stated that “while the challenges we face are always evolving, the Fed’s approach will remain the same” (1). Until evidence is observed that proves real changes have been experienced in the economy, Powell is unlikely to deviate from the current plan of three interest rate increases throughout 2018 (2). While prices have risen in some areas, specifically wages, the medium-term focus of the Fed makes any further increase in the FFR unlikely. Referring to abnormally low inflation experienced in 2017, Cleveland Fed President Loretta Mester claims “as we didn’t overreact to last summer’s weaker inflation readings, we shouldn’t overreact to these increases either” (2). This statement illustrates the regressive expectation held by many Fed members that long term inflation will remain around two percent. A change in this expectation must happen before the Fed will become more aggressive in its policy decisions. With the recently proposed tax cuts, it is entirely possible that economic growth will accelerate even further, increasing the likelihood the Fed diverges from its current plan. It is unlikely the Fed has enough evidence to currently justify any further hike in rates, but if these trends extend past the short run, the Fed is likely to become more aggressive in 2019 and beyond.
As January had greater than expected job and wage growth, investors urge the Fed to increase interest rates, fighting off anticipated inflation. In conjunction with a corporate friendly tax reform, investors are worried about the economy overheating. However, the economy might not be as hot as Wall street think. Wage growth has been lagging the Fed’s target since the end of the recession in June 2009 (1). 3.5% wage growth is consistent with the Fed’s inflation target of 2%. FRED data shows wage growth at a modest 2.141% (2). The Fed’s projection for the PCE growth rate in 2019 is 2%, with another increase in 2020 (to 2.05%). However, if the Fed increases rates prematurely, the recovery currently in progress could stagnate; pulling growth rates even lower from mid-2009 projections. Keep in mind that the 2% inflation rate is a target average, so it can be beneficial to go above the specified value sometimes (in this case being 2%). Chairman Powell said in a statement early February “I want to stress my commitment to explaining what we’re doing and why we are doing it.” (3). This is a general statement, but it has the tone that Powell isn’t looking to do anything unpredictable, like unexpectedly increasing interest rates. Although the market experienced a correction recently, I believe the full magnitude of the economic recovery have yet to be felt by households.
Due to tax cuts some economists theorize that household spending will increase faster than output growth which raises concerns about the stability of the economy. The fear is that inflation will increase quickly resulting in the Federal Reserve being forced to raise interest rates faster than the markets expect which people fear could spur an economic downturn. Some indicators show unemployment is low, consumer confidence is higher than it has been, businesses have also increased their confidence which all points to an economy running “hot”(1). Fed Chair Powell will not be testifying until February 28th on the semi-annual testimony on the economy, however, people speculate that he will hike rates.one economist forecasted four rate rises this year which would be double the pace the market currently expects (2). Inflation expectations continue to rise so it is not unfathomable that the Fed would increase rates to match. These expectations pair with continued low unemployment will push the Fed towards this choice of action. However, other economists argue that since previous Federal Reserve rate hikes haven’t been felt very “hard” in the market, these rate hikes could be the same way—market rates may be sluggish to respond (2). Another concern is that the Fed may choose the other course of action and slow down rate hikes to alleviate investor anxiety caused by the recent dip in the stock prices (3). Since the decrease in stock market prices were a response to fear of potentially drastic increases in interest rates, not raising them for a while then continuing with the plan to hike up interest rates may give the stock market time to regain stability.
Although goods price inflation and asset price inflation may appear to be essentially the same, the two are very different. Goods price inflation can be thought about in the conventional sense; A general increase in the prices of goods and services over a period of time (1). During the financial crisis of 2008-2009, the Fed sought to create an inflationary environment to spur the economy. To do this, they created, among numerous other programs, a program to buy mortgage-backed securities and government debt (2). The goal of this program was not necessary to lower interest rates further as many people think, but to incite asset price inflation (3). Asset price inflation is like “normal” inflation, except it is restricted to the prices of financial instruments, like stocks and bonds, rather than goods and services (4). The Fed attempted to create asset price inflation to take advantage of the wealth effect (3). The wealth effect is when the price of financial assets goes up, the holders of those assets feel wealthier and thus spend more, even if they have no additional cash (5). The wealth effect can lead to goods price inflation when the holders of financial assets decide to spend more, thus pulling the economy out of a recession or depression. In addition, the inflated asset prices help decrease leverage ratios. When companies’ balance sheets appear healthier, they are more incentivized to make loans, thus helping the economy further (3).
The drastic decrease in the S&P 500 and Dow Jones following the Senates overwhelming approval of Jerome Powell reflects the economies strong effect on equity markets. Speculation over the past month has led many investors to believe that most of the equity markets are overvalued, and that expansionary fiscal policy could have negative effects on the economy. The Trump tax plan is expected to boost economic growth without putting upward pressure on prices (A). This increase in growth without prices following suit leads many economists to believe that the Federal Reserve Bank will continue to raise interest rates to slow down the economy. The FOMC current inflation goal of two percent is not being met, and this will likely increase the chances of an effort by the central bank to slow down current growth to a sustainable rate. With these factors in place the US has begun to increase its chances at a hard landing. According to Barclays the risk of a hard landing increased significantly following the revealing of the tax overhaul, their forecast indicate household spending will increase at a faster rate than business investment can improve productivity, resulting in an output gap (B). While a hard landing may not be likely, the drastic decreases could be a likely indicator of the health of the US economy.
The economy has grown quickly since Donald Trump has been in office. After a year of growth, December saw record highs in the stock market and job market which had some people optimistic of even more future growth, and others weary that we are due for a downturn soon. Donald Trump’s economic stimulation plan has successfully done what it has promised so far, to grow the job market. However, I believe Jerome Powell will take measures to balance out Trump’s aggressive economic stimulation plans. I believe the Fed will slowly raise the interest rates to prevent the job market from growing too quickly. More jobs have already lead to lower working hours for some employees, and lower taxes are leading to higher inflation. As investors are questioning the future of the economy, I predict the rate of investment will raise in the coming months to take advantage of the low interest rates before they are expected to raise. In regard to consumption, despite the current tax cuts that are intended to stimulate current spending, I think people will save their money (as interest rates begin to raise) to have more disposable income when taxes inevitable raise in the future. Current expectations have already prevented the economy from surging farther than where it was in December. For that reason, I believe Powell will not be too aggressive in raising interest rates, because battling Trump’s economic plan too harshly could cause turmoil in the economy. I don’t believe the US is at risk of a hard landing because I predict the Fed will take measures to control inflation, which will control the rate at which the economy grows. The Great Recession of 2008 is still fresh in everyone’s mind and I’m sure Jerome Powell does not want his first year as FOMC chair to lead to America’s next recession.
The Central Bank has a critical role of dealing with financial crises in a supervisory role. Through the instrument of quantitative easing, the Central Bank has the ability to manipulate the money supply through large-scale asset purchases (usually government bonds). With the money it has created, it creates more usable funds in the financial system, which reduces interest rates in order to get businesses and investors to borrow more (1). This type of implementation affects the price of assets due to the response of new information. Although the macro effects of quantitative easing are still debated, Cecchetti and Genberg believe that the importance of asset price and goods price inflation through quantitative easing should be both be considered in policy making (2).
Asset price inflation can be practiced in the form of raising prices of housing, land, or other equities (2). The argument for the purpose of asset price inflation is to control the strength of financial balance sheets. This requires prevention of weakening the quality of the assets. Goods price inflation is usually associated with the Consumer Price Index (CPI). This type of inflation is measured with market baskets. Over the last 12 months, all items in the index rose 2.1% before seasonal adjustment (3).
In response to the 2008 financial crisis, the Fed got involved as lenders of last resorts. The Fed lent to banks who in return, provided cash to money market funds by purchasing some of Lehman’s assets (4). This sort of manipulation could be considered as a life-saving use of altering asset prices through quantitative easing. This greater purpose of providing liquidity where necessary to fundamentally solvent institutions is one way the Central Bank and the Fed have at handling financial crises.
It is true that in the end of the day for the 2008 financial crisis the Fed needed to be the lender of last resort but should the Fed continue the role of being the lender of last resort or let businesses taking huge risks just be punished? It is a tough question because the Fed saved the economy from a complete meltdown in 2008 but that action left a consequence of banks making large risks because they are under the pretense that they will be bailed out.
When looking at research by multiple parties, the conclusion can be made that the U.S. economy has been doing well throughout recent years. This is no secret as the civilian unemployment rate in the U.S. is down to 4.1%, average hourly wages have increase 9 cents or 0.3% and an index measuring consumer confidence increased from 95.7 to 99.9 in January. Clearly, the economy is doing well, however, this bear market may be a warning sign for the Fed. They may have to take significant action, different from what they originally expected.
Originally, Powell and company wanted to gradually raise interest rates on bonds. Now, all signs point to the fact that the economy has gotten more than the lift it needed, and as Jim Vogel, head interest-rate strategist at FTN Financial, said in an article done by the Wall Street Journal, interest rates were kept low because of secular stagnation. Wages, prices and inflation are increasing, and the Fed has to worry about inflation that did not take place throughout the recovery of the Great Recession when interest rates were kept low. These things said, it is reasonable to expect the Fed to raise interest rates faster than expected; as a matter of fact, it has already taken actions to increase its rate faster than expected as interest rates have reached close to 3%, the highest they have been in three years. As a result, hard landing may be a possibility but a period of market correction may be a necessity given the current economic state of the U.S..
I do not think that this market correction will lead to a recession. According to Goldman Sachs only 12 of the 36 recorded corrections measured in the S&P 500 since World War II have resulted in a recession. This suggests that there may be some correlation, but a market correction does not always lead to a recession. Inflation is around two percent and wage growth has finally begun to pick up again. The Fed will most likely tighten monetary policy to hinder inflation and wage growth, but that is their job and these numbers are not abnormally high and thus do not indicate that a recession is looming. Furthermore, the stock market is not an economic indicator. I would argue that the correction could have been healthy in that assets were overpriced, and a market correction leads to them being priced more accurately. This would help prevent a bubble scenario from happening where asset prices continue to rise until they don’t anymore and there is a crash, which could end up leading to a recession. Overall there is not enough evidence right now to indicate that a recession is coming soon.
I do not believe the Fed is going to be raising interest rates faster than expected. They have already planned and voted on raising the rate three times this year (1). One item we have discussed in class is that business plan for what is expected to happen in the future so a fourth rate increase may have the opposite effect. Instead of curtailing the problem it may cause more instability do to the unexpected rates. The Feds primary goal after the sudden volatility in the stock market is going to be to slow the job growth to keep it strong without negatively affecting the economic growth (1). Many economists during the month of January after the end of 2017 gave their insight which all concluded this taxes cuts would boost jobs and the economy and it mostly likely be short-lived (2). They were partially correct because two weeks after the article came out there was a sudden jump in the stock market followed by an immediate massive drop. Leading to the idea that yes, the business investment and higher wages did lead to an increase. However, it came so quick that it destabilized the markets a bit. This caused people to believe there are issues in the economy instead of the economy trying to adjust to the current policy changes and before the Fed implemented the rest of the expected rate increases.
When predicting the health of the economy, it is important to notice that economic indicators do not have the certainty and weight that they are often believed to possess. For example, back in 2007 before the economic crisis, the leading indicators showed that the economy would experience slower growth than anticipated but otherwise had no reason to worry about an impending economic upheaval. With that being said, the federal funds rate is not even on the list of important economic indicators and thus cannot even be considered a sign of imminent disaster when it doesn’t have enough certainty and weight to be deemed an indicator. Similarly, the same case can be made with the stock indexes as well. The stock market is such a volatile and inconsistent measurement of economic health that if they were perceived as strong economic indicators, the world would be in uproar and fearing the economic apocalypse on an almost regular basis. Finally, to address the fears caused by the economic indicators that are rising at a faster than normal rate, as the market watch article said, there was no major increase in inflation. Thus, indicating that maybe these indicator increases are not as alarming as one may believe. The main tenet of Lucas’ critique then takes effect, meaning that a proper assessment of the economy cannot be made by using past standards due to a change in environment caused by the policies previously implemented.
Since the Great Recession, the economy has been recovering with a low Federal Funds rate, through the efforts of quantitative easing (1). The Federal Funds Rate was near zero and has recently started to rise again, now being approximately 1.5% (2). This increases the opportunity cost of investing in the stock market because banks and individuals can now earn more return on safer investments, such as Treasury Bonds and CDs. The increase in the opportunity cost along with expectations of an overheated economy makes the stock market less favorable. In a sort of self-fulfilling prophecy, the expectations of a volatile stock market led to it dropping 4.2%. Investors are feeling more cautious, which points to the possibility of the US experiencing a hard landing in the near future, an additional possibility due to the passed tax cuts. The tax cuts could lead to a hard landing by “stimulating household spending faster than business investment” which will lead to an increased demand for labor (4). Last month the nominal unemployment rate was 4.1%, which has been decreasing in a roughly steady fashion since the Great Recession, in which it peaked at 10% (3). If unemployment is too low, the US risks being inefficient, for the cost of labor is constant while the output produced diminishes. With rising employment comes wage inflation—to keep up with the increased demand for labor. Inflation will also increase due to increased consumer spending. In order to keep inflation under control, the Fed will raise interest rates, which could cause an economic downturn if increased too rapidly (4).
A “hard landing” certainly seems plausible for the United States economy based on a few factors. President Trump’s most recent economic policies have seemed to create the opposite effect of what was intended. According to investors, his tax cuts in particular will boost consumer confidence to the point where the economy will become overwhelmed. This in turn will force the Federal Reserve to raise interest rates quicker than anticipated in an effort to counteract the increased inflation that results from more spending from consumers, which “could quickly tighten credit conditions and thus prompt an economic downturn”. The increased growth in wages and hiring due to the 17-year low unemployment rate also displays evidence of a potential hard landing. “Average hourly wages jumped 9 cents, or 0.3%, to $26.74. That pushed the yearly increase to 2.9% from 2.6%…” marking the highest yearly wage increase level since the end of the Great Recession. A recession for the United States economy due to increased consumer hubris and growth in wages may not mean a recession is imminent but it is certainly in the cards.
It should be noted that consumer price inflation and asset inflation are not the same measurement. The Consumer Price Index is used to measure inflation and can serve as an economic indicator. The President, Congress, and the Federal Reserve Board use the trends in the CPI to help in the development of fiscal and monetary policies (1). The CPI, however, is a measurement of prices paid by consumers for goods and services which does not include the assets. By targeting the asset inflation through quantitative easing, the stock market will experience stimulation and an increase in stock prices (2). This provides explanation as to why the Dow and the S&P 500 hit all-time highs while inflation largely lags behind the medium-term goals of the fed. This stimulation has no effect on inflation so what is the potential benefit. One potential benefit of asset inflation targeting lies in the “wealth effect” where a rising stock market leads to an increase in net worth which should then increase spending (consumer price inflation that can be used as an economic indicator). The problem with this is that many studies show that this is not typical behavior of the financial sector (2). Quantitative easing for asset inflation, therefore, does not seem to be entirely beneficial at this stage in the U.S. economy. Similar to the 2008 recession, too much growth can lead to asset deflation which can cause an economic recession.
Mr. Rosengren noted that he and some private sector economists believe “the U.S. economy is healthier than financial markets expect.” In financial markets, investors expect the Fed to raise rates by only a quarter of a percentage point in each of the next three years.
“The shallow path of rate hikes priced in by financial markets could increase the need for the Fed to eventually raise rates more quickly than is appropriate, thereby jeopardizing the recovery and growth process,” Mr. Rosengren said.
Lower interest rates would encourage businesses and investors of excessive risk and excessive leverage, this will have a great risk in the economic downturn. It is important that the high price of assets is caused by low interest rates and the fed’s policy, and the fed should not only be responsible for all the previous bubble, but also for the biggest bubble foam (now).
Low interest rates will ultimately lead to financial crisis, and only higher interest rates will lead to the final result is not the end of the world.
Review the past two recessions, will find that inflation is not out of control. In this case, asset prices rise first and then fall. Therefore, if the government’s aim is to avoid a recession, I think we need to be very focused on asset prices, rather than just inflation. If you want to avoid a recession in the future, we must consider changes in asset prices
The fed may still be ignoring all the rest are obvious, but the problem is that more and more ordinary people realize that, in the s&p index rose 27%, while wages for 10 years in a row almost without rising, some things are disastrous. The federal reserve for liquidity all tasks is to make the richest 0.01% of the rich people than ever before, it will destroy the middle class.