Interest rates still aren't low enough to stimulate the U.S. economy. Washington needs to engender more inflation so "real" rates turn substantially negative
Can an interest rate of zero be too high? Unfortunately, yes. A new analysis by Goldman Sachs (GS) concludes that the Federal Reserve's cut in the federal funds rate to a record low of zero to 0.25% on Dec. 16 isn't going to be nearly enough to get the economy going again. The report says the Fed would need to reduce the federal funds rate to negative 6% by the end of 2010 to supply the needed amount of monetary stimulus.
The problem: It's literally impossible to cut interest rates below zero. As a result, "we are entering a world with interest rates that are far too high for the economy's good," Goldman Chief U.S. Economist Jan Hatzius wrote in a Jan. 16 research note.
That's a big negative for a U.S. economy that's already in a deep slump, with retail sales, industrial production, and exports all plummeting. Citigroup (C), Bank of America (BAC), General Motors (GM), and Chrysler, among others, are struggling to keep their heads above water. Circuit City, the second-biggest U.S. electronics retailer, announced on Jan. 16 that it was going out of business and closing all its stores by the end of March. Meanwhile, homebuilders like Lennar (LEN) and D.R. Horton (DHI) are getting squeezed by a record decline in home prices.
Inflation Headed to Zero?
Ordinarily when the economy slows, the Federal Reserve can juice it up by cutting short-term interest rates to below the rate of inflation, meaning that in inflation-adjusted terms, rates are actually negative. For example, if inflation is running at 6% per year and interest rates are at 4%, the "real" rate is negative 2%. Negative real rates entice people to borrow money for consumption or investment, which gets the economy going again and soaks up unemployed workers and equipment.
Right now, zero is about right for interest rates. But the economy is continuing to soften, so it will soon be too high, according to Goldman. Hatzius bases his calculation on Goldman's own version of the so-called Taylor Rule, which is named after Stanford University economist John Taylor. Taylor says the Fed needs to lean against the wind by raising rates when the economy is overheating and lowering them when there's a lot of slack.
Trouble is, the Federal Reserve can't cut interest rates below the rate of inflation if inflation falls to zero, which many economists expect to happen soon. Clearly the Fed can't take in $1,000 and pay back only, say, $950 a year later. Rational investors would simply keep their money in cash outside the banking system to preserve its value.
The solution is obvious: The Fed needs to deliberately raise the rate of inflation-maybe not all the way to 6%, but significantly above zero.
One way to do that is to print lots of money. The Fed can create money from thin air by purchasing assets such as Treasuries and mortgage-backed securities and paying for them by crediting the seller with newly created reserves at the central bank.
"Usual Rules No Longer Apply"
That way today's zero interest rates would be negative in inflation-adjusted terms and the economy would get the boost it needs. Fed rate-setters would need to swallow hard, since 99.99% of the time they try to quell inflation, not raise it. But most of the voters on the Federal Open Market Committee are aware that deflation can be an even greater nemesis than inflation.
Even generating negative real rates won't be enough to turn the economy around. So the government will also need to strengthen the banking system and give the economy a fiscal stimulus by cutting taxes and increasing government spending, as the Obama Administration proposes to do. To rescue the banks, Hatzius favors more purchases of bad assets that are on banks' balance sheets as well as lending by the Fed against consumer asset-backed securities.
Princeton University economist Paul Krugman favorably cited Hatzius' research in his New York Times blog on Jan. 17. No surprise there, since Krugman himself pinpointed a similar problem in Japan during its "lost decade" of slow economic growth in the 1990s. Wrote Krugman: "This is why we need a huge fiscal stimulus, unconventional monetary policy, and anything else you can think of to fight this slump. Quite literally, the usual rules no longer apply."
UPDATE: Goldman Sachs' Hatzius returned my phone call on Jan. 21 and spelled out what he thinks is the right strategy to combat the recession. To be absolutely clear, Hatzius does not think the government should try to get inflation up to 6% or anywhere close to it. Hatzius said that since the Fed can't reduce interest rates below zero, the government has to use other tools that would give an amount of stimulus equivalent to an interest rate cut of 6% or more. That would be a combination of fiscal stimulus (tax cuts and spending); efforts to get the banks lending again; and monetary stimulus such as increasing the money supply. The goal, says Hatzius, would be to get the inflation rate back up to around 1% or 2%. That's believed to be the Fed's target range.
By Peter Coy
Coy is BusinessWeek's Economics editor.
Paul Stillwaggon,
For All Your Real Estate Needs
Contact New Jersey Estates
Real Estate Group
E-mail: njestates@gmail.com
Web: http://www.newjerseyestates.net
908-561-5492 (Paul S) 908-310-1358 (Cell) |
|
NJ Estates Real Estate Group
Weichert Realtors
908-561-5492
55 Stirling Road, Watchung, N.J. 07069
|
Equal Housing Opportunity |
Current Listings Info
Luxury New Homes
Custom Build A New Home
Land & Building Lots
New Jersey Estates
All New Jersey Homes
Real Estate Listings Blogs
Real Estate Info Blogs
Open Houses & Directions
Our Testimonial Letters
Going Green/ Complete Info
Frank J. Festa
REALTOR-ASSOCIATE®
Office: 908-561-5400 Ext. 2116
Direct: 908-561-6499 Cell:908-295-1639
Weichert Realtors
NJ Estates / Real Estate Group
55 Stirling Road, Watchung, NJ, 07069
Web- http://www.njestates.net
Email- frankfesta4076@gmail.com
Blogs- http://activerain.com/blogs/genna
Twitter- http://twitter.com/njestates1
