INSUBCONTINENT EXCLUSIVE:
It was only a few months ago that the US Federal Reserve was intent on continuing to increase interest rates
But now, some policy makers are even hinting that the next move may be a rate cut, and they may even pursue other forms of policy easing
despite equities reaching record highs again
If that is the message Fed Chairman Jerome Powell will provide at his press conference Wednesday following a twoday meeting with policy
makers, it would spur equities to even greater heights and drive yields on Treasury securities even lower.
To see why this is a likely
scenario, it helps to understand why the move toward further policy easing may occur
Maintaining healthy employment and stable inflation are the twin objectives of Fed policy
Since the 2008 financial crisis, three Fed chairs have attempted without success to reach and sustain a 2 per cent inflation goal
They rationalized that near-zero interest rates and three bouts of quantitative easing would take the economy toward that target
But despite the Fed’s balance sheet having more than quintupled from $800 billion in late 2008 to a peak of $4.5 trillion by 2015,
inflationary pressures have remained dormant.
The inflation numbers for the first quarter released Friday showed a further easing of
The core personal consumption deflator that excludes food and energy fell from an already low 1.8 per cent in the final quarter of 2018 to
1.3 per cent in the first three months of 2019
Inflation this low could quickly turn into deflation, as has been Japan’s experiencesince the early 1990s
Negative inflationary expectations become self-sustaining since they encourage consumers and investors to postpone spending, further
deepening a downturn.
Federal Reserve Bank of Chicago President Charles Evans told the Wall Street Journal this month that if the core
inflation rate held at around the 1.5 per cent area for a few months, he “would definitely be thinking about taking insurance” by
Robert Kaplan, head of the Federal Reserve Bank of Dallas, also indicated that if inflation persisted at low levels, he would have to take
that into account in setting rates.
Even if Powell suggests at his May 1 press conference that such a move could occur within a few months,
that may not be the end of the easing cycle
The Fed is unlikely to succeed in raising the inflation rate now any more than it has been able to do in the past decade
Even if a rate cut is accompanied by an announcement that the Fed would resume bond purchases, that may not pressure inflation higher.
Low
inflation in recent years has been the result of an aging US population that tends to consume less, Trump administration policies that have
discouraged immigration of young workers who could have contributed to spending, and a labor force participation rate that is still below
These issues are structural and do not respond to monetary stimulus measures
Furthermore, if rates are reduced, low- and middle-income workers will find themselves losing out on interest income as they did in the
This too will curb consumption and hold back inflation.
Under these circumstances, the Fed will likely double up on policies that don’t
work, sending financial asset prices even higher; failure may only breed further efforts in the same direction
This expectation is borne of experience
When the Fed deemed that the first effort at quantitative easing that was announced in late 2008 was not sufficient to spark faster
inflation and put economic growth at an acceptable pace, it introduced second and third versions of bond purchases, providing a backstop to
financial assets for several years.