The man behind the curtain has spoken, and it appears to be ‘good’ news:
Federal Reserve Chairman Alan Greenspan said Thursday that the economy seems to be on a ”reasonably firm footing,” with inflation under control.
Fed Chairman’s Remarks In his most extensive remarks on the state of the economy since February, Greenspan said that a recent uptick in economic indicators showed the soft readings of the early spring were not signaling a more serious slowdown in the pace of activity.
Greenspan’s generally upbeat assessment of the economy provided support for the view that the Fed, which has raised interest rates eight times over the past year, planned to continue nudging rates higher at a gradual pace.
”The U.S. economy seems to be on a reasonably firm footing, and underlying inflation remains contained,” Greenspan said in remarks to the congressional Joint Economic Committee.
Greenspan said because of this the Fed was able at its last meeting to repeat a pledge it has been making for the past year that it will be able to move rates higher ”at a pace that is likely to be measured.”
If the economy is in good shape, and inflation is under control, why do we need to keep increasing interest rates? I thought the general theory was that higher interests rates = slower growth = low inflation, so I do not understand the necessity of increasing interest rates to curb inflation. Have I missed some wild expansion in the economy or something?
Shouldn’t they just leave things alone, rather than doing anything? Is this an instance where they just feel the need to constantly be doing ‘something,’ rather than standing back and letting things work out on their own? It seems to me that interest rates are a pretty blunt instrument, so you would avoid using them if ast all possible
Again, remember who you are dealing with when you provide an explanation in the comments. Small words are appreciated good.
KC
Kevin Drum will have some analysis, maybe a chart or two.
Hokie
To fight deflationary pressures, one needs some room to cut interest rates so that employment can pick up (essentially, the way a central bank fights deflation is through, well, printing more money, which means you have to be able to cut interest rates to balance). Once employment picks back up and the economy’s going again, prices stop falling.
But if interest rates are already rock bottom, you’re going to slide into the liquidity trap…interest rates are so low that there’s no incentive to lend money, so any extra money doesn’t flow. This renders monetary policy completely ineffective, and means deflation is all but assured. Japan in the 90s is a perfect example, and there’s been a lot of recent scholarship on how what happened in Japan could happen here. The Fed seems to be reasonably worried about this.
The housing bubble is especially worrisome, because lots of people are buying homes without needing to pay interest. Right now, housing is one of the main pillars of the economy. Eventually, though, this rate will fall, and it could be dramatic, which could ignite a deflationary spiral as demand plunges. Raising interest rates would help cool it off.
And of course, a deflationary slump could trigger a complete crashing of the dollar.
Hokie
Err, ignore that bit about “needing to cut interest rates to balance.” Interest rates’ll fall naturally as more money’s printed.
Nonnymouse
Boosting interest rates makes the dollar more attractive to foreign investors and increases its value relative to other currencies. We import a lot, and the people we import from are going to start raising prices if we don’t prop up the dollar better. Plus the housing bubble is due for a good popping.
Nonnymouse
Boosting interest rates makes the dollar more attractive to foreign investors and increases its value relative to other currencies. We import a lot, and the people we import from are going to start raising prices if we don’t prop up the dollar better. Plus the housing bubble is due for a good popping.
shawn
I think the one of the biggest concerns right now is the yield curve. From a MSNBC article this am called “Greenspan wrestling with rate ‘conundrum'”
paul lukasiak
the reason we need to raise rates now is that they remain at historically low levels — and unless we raise rates now, when another recession does hit it will be impossible to lower rates enough to stimulate the economy.
Kimmitt
Paul’s right in that area, and I think that there is ongoing concern about deflating the housing bubble before it pops. It is conventional wisdom that the bubble is at least partially fueled by current low interest rates.
caroline
As I understand it, higher interest rates make the US more attractive to foreign investors. Right now with the twin deficits our financial situation isn’t very attractive to them.
Kimmitt
I’m sorry, Caroline, but that’s not correct; any current accounts deficit (i.e. trade deficit) must be financed by foreign investment in the US (like a Chinese firm buying IBM), while a great deal of our Federal deficit is financed by foreign buyers in the UK (and other places) and the central banks of Japan, South Korea, and China.
caroline
Kimmitt,
That’s pretty much what I was trying to say. I guess I didn’t make my self clear. I should have not used investors. I was looking for a word to describe those who would be financing our debt.
Kimmitt
I prefer “suckers.” ;)
We seem to be able to float an essentially infinite amount of debt at very low rates at this point. Dunno what that means, really.