Economists estimate that the Fed has to cut interest rates about 350 basis points (3.5%) to offset the effects of a recession and stimulate a return to growth. The entire world seems headed in the same direction. Japan has been in depression for over 25 years the U.S. has been in a depression since 2007 (defined as persistent below-trend growth). If the Fed cannot cut rates enough to get the economy out of recession, it could become a permanent depression, as happened in Japan. economy may be in recession before the Fed can normalize interest rates. The Fed needs to raise interest rates so they can cut them when recession hits. The fourth constraint on the Fed is their desperate race against time. out of its flat-line growth trend this year. That won’t happen until February 2017 at the earliest. They need to see which parties control the House and Senate and then try to achieve some consensus on a new spending program. has to get past the presidential election.
Unfortunately for the Fed, there’s almost no possibility of helicopter money this year. The debt would stay buried on the Fed’s balance sheet possibly forever if “perpetual” bonds were used. Then the Fed would buy the bonds with printed money and promise never to sell the bonds. The Treasury would finance the deficits by issuing more bonds. The Fed might be able to cause some inflation if they could employ “helicopter money.” The use of helicopter money requires cooperation among the White House, Congress and the Fed.īasically, the White House and Congress would agree on massive spending programs and larger deficits. The third constraint on the Fed is political gridlock. That’s not enough to sustain deficits of over 3%. With 1.5% inflation and 1.23% real growth, nominal growth is still only 2.73%. The problem is that inflation is not 2% (what the Fed wants). Since debt is repaid with nominal, not real, dollars, then 4% nominal growth is enough to make debt sustainable even if deficits are 3% per year. For example, if real growth is 2% and inflation is 2%, then nominal growth is 4%. Nominal growth is what you get when you add inflation to real growth. Making the debt burden sustainable is not about real growth it’s about nominal growth. debt problem because it would lower the real cost of the debt. (Inflation is not a good deal for you, but the Fed doesn’t care about you. That’s important because the Fed’s government debt problems could be solved with some inflation. But there are powerful deflationary forces arising from demographics, debt, deleveraging and technology. economy is not yet in outright deflation. The second constraint on the Fed is a persistent deflationary tendency. economy has flat-lined at a level that cannot sustain our deficit spending. Deficits are still running over 3% per year and set to skyrocket as baby boomers retire and claim Social Security and Medicare benefits. Finally, there is a trend, and it’s not a good one.Īnnualized real growth for the past four quarters has been 2.0%, 0.9%, 0.8% and 1.2%, for average growth of 1.23%. We have not seen persistent growth or a definite trend - until now. Quarterly GDP figures have been volatile over the past three years, with annualized real growth as high as 5% in the third quarter of 2014 and as low as minus 1.2% in the first quarter of 2014. The first and most important constraint on Fed policy is that the U.S. Let’s look at some of the constraints on Yellen - and the possible “tricks” she might use to escape. dollar and a possible sovereign debt crisis for the United States.
Yellen and the Fed face as many constraints as Harry Houdini in trying to escape a potential collapse of confidence in the U.S.
Investors who see this coming stand to make spectacular gains. Yellen’s only escape is to trash the dollar.
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Yet there is one way for Yellen and the Fed to break free of their economic handcuffs, at least in the short run. Yellen is handcuffed by weak growth, persistent deflationary trends, political gridlock and eight years of market manipulation from which there appears to be no escape. Now Janet Yellen will try to become the greatest escape artist of the 21st century. He escaped from specially made handcuffs, underwater trunks and once escaped from being buried alive. Harry Houdini was the greatest escape artist of the 20th century.
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