The deflated inflationary fears are ruffling feathers
During the summer, inflation seemed to be one of the largest problems on the economical agenda. Trying to balance slowing growth and rising inflation was one of the largest dilemmas policy-makers were facing. Now it seems the trend has reversed: slowing growth is still a worry, while inflation management has become deflation management. According to Kazumasa Iwata, former deputy governor of the Bank of Japan, "the U.S. Federal Reserve has shifted its monetary policy toward flooding the economy with cash and away from targeting interest-rate levels". Japan might be useful as a successful precedent of advanced economies combating deflation as the BoJ kept interest rates close to zero from 2001-2006 and supplied ample cash into the economy in order to keep deflation under control. In Japan, this strategy worked well as it eased liquidity and restored confidence in the market.
The Fed cut rates by 150 basis points (1.5%) on October 29th to 1.00% and the ECB followed suit by cutting rates by 50 bps to 3.25% on November 6th. On the same day, the BoE responded with a clean 150 bps cut to 3.0%. The Fed is now largely expected to cut its rates a further 50 bps at its next meeting on December the 16th. The record fall in US consumer prices in October triggered the vast programme of fighting deflation. Don Kohn, the Fed vice chairman, assured that the US will take every step necessary to ensure the US does not fall prey to deflation.
In the past months, the Fed has already widened the discount window and aggressively cut interest rates. There are still several tools in its arsenal in order to stave off inflation, such as providing fiscal stimulus, lending through government agencies such as Fannie Mae/Freddie Mac, committing to lower overnight rates for a considerable period, purchase of longer term bonds to lower long-term rates and purchase of risky assets. The $800 billion stimulus package to ease lending and offering a market to asset-backed securities already shows some of these tools in use. The threat of deflation is even worse off with the risk of debt deflation: the collateral which secures a debt falls in value, leading to a forced devaluation of the debt, which in turn causes further falls in collateral value. For example, a mortgage in which the market value of the property falls below the price of the loan. Some might argue this is already taking place with US subprime-backed assets - the eagle of the American economy is in for a rough flight.
3 comments:
What do you think will happen with interest rates next year? Will interest rates remain low or increase soon again? Personally I believe we will ha low interest rates for at least another two years. What is your opinion?
Considering the current deepening recession in the US, it is highly unlikely that we will see rate hikes anytime soon. The US announced the biggest drop in U.S. consumer spending in seven years which only adds on to the piles of discerning data - the Fed's priority is getting the economy rolling again and it will keep rates low until that happens. In Europe, the ECB has a tougher challenge as it must balance several different economies at once and primarily focus on keeping inflation within target levels. With deflation looming, more rate cuts are likely in Europe as well but they will not be as drastic or prolonged as in the US. The BoE on the other hand has much room to cut rates, as it has consistently kept rates above the ECB and Fed levels - I expect the gloom of the UK economy will cause interest rates to be cut harshly in the near future.
The duration of the crisis and the levels of inflation/deflation will determine how long rates stay low, but I believe the first round of rate hikes will come earliest in the third quarter of 2009 once companies earnings have begun recovering.
Thank you very much for writing such an interesting article on this topic. This has really made me think and I hope to read more. Personal tax return Ottawa
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