CHANGING MY TUNE ON THE FEDERAL RESERVE

CHANGING MY TUNE ON THE FEDERAL RESERVE

Don’t let the title fool you too much. I am certainly not about the give the Fed “kudos” for its monetary policy over the past year. I am, however, going to retract my statement that the Fed needs to raise interest rates. At this point in our business cycle, with continuing deterioration in growth and inflation already being priced into our economy, the Fed needs to hold on rate changes.

If the Fed were to raise interest rates, it would do very little to curb the inflation situation short term as the inflation is currently being digested through our economic system (and like things that are being digested, it simply cannot disappear). Raising rates now would deteriorate growth further and have no change on inflation. This would make growth even more susceptible the inflationary pressures as less liquidity causing further cuts in spending by both businesses and the consumer.

With the recent decline in oil and slight rise in the dollar, the economy is going to have the opportunity to breathe as inflation is expected to stop increasing (notice I did not say moderate, I believe that the inflation rate while high, will stop increasing). Unfortunately, an impending global recession could spell more challenges for the economy.

With Germany, France, and Japan (plus others) reporting negative GDP growth, demand for U.S. exports is expected to decline over the next year. Without our booming export industry, our GDP would be close to -1%. Fewer exports would likely lead to fewer jobs and less consumer spending. This, coupled with the economy’s inability to shake off the housing recession, will certainly lead to -2% growth for 2009.

Fortunately, the dollar will strengthen and if the U.S. does fall into a recession, inflation will begin to decline. However, if pressure returns in the commodity markets before economic recovery begins, the recession will likely last longer. In plain English, I am changing my monetary policy position to “hold” and downgrading my economic forecast for 2009.

I will be writing more on the Obama economic policy in the future. I am still reading the policy, but have not found much worth discussing.