Federal Reserve & Interest Rates

Fed Chairman Ben S. Bernanke gave a testimony Before the Committee on the Budget, U.S. House of Representatives. He discussed the economic outlook. He expressed concerns about inflation. The Chairman described the inflation problems as follows:

The same increase in oil prices that may be a negative influence on growth is also lifting overall consumer prices. Last year, food prices also increased exceptionally rapidly by recent standards, further boosting overall consumer price inflation. The most recent reading on overall personal consumption expenditure inflation showed that prices in November were 3.6 percent higher than they were a year earlier. Core price inflation (which excludes prices of food and energy) has stepped up recently as well, with November prices up almost 2-1/4 percent from a year earlier. Part of this rise may reflect pass-through of energy costs to the prices of core consumer goods and services, as well as the effects of the depreciation of the dollar on import prices, although some other prices

Bernanke went on to say that the markets suggest that the decline of food and energy prices will begin during this year. Core inflation should moderate for about two years, as long “as the public’s confidence in the Federal Reserve’s commitment to price stability is unshaken,” the Chairman said. He also noted that if the well-anchored public expectations of inflation in the future destabilize, it could “greatly complicate the task of sustaining price stability…” The Federal Reserve will be monitoring inflation, and public expectations continuously.

According to the Associated Press, “inflation is at the highest rate in almost two decades. Consumer prices rose by 4.1 percent for all of 2007, up sharply from a 2.5 percent increase in 2006, the Labor Department said Wednesday. Consumers felt the pain when they filled up their gas tanks or shopped for groceries. Prices for both energy and food shot up by the largest amount since 1990.”

Reuters columnist James Shaft thinks that we have more pressing concerns than inflation. After interviewing economic advisor George Magnus, Shaft reported the following comments: “The strong probability is that we will get at least disinflation in 2008,” said George Magnus, senior economic advisor to UBS. He continued, “I’m not aware of any banking crisis in history, almost without exception, that was not accompanied by falling inflation.”

The FOMC has made it clear recently that they are poised to cut rates at the next meeting. Magnus expressed to Shaft that “even aggressive cuts in interest rates will have a limited and painfully slow impact on demand under these circumstances…When solvency is involved and asset prices are declining, monetary policy can help but can’t solve the problem.”

Inflation is at the forefront of concerns for the Fed, as it has been for the passed several months. It isn’t something to panic about for now, however, it should not come as a surprise if we pay more for our milk and bread.

The Philadelphia Federal Reserve reported that their regional manufacturing survey revealed a negative 20.9 rating in the amount of activity.  Stocks slipped on Thursday shortly after the announcement.

The Dow Jones fell around 200 points.  All major indexes were off by more than 1 percent.  Openings today were high, however gains were quickly lost after the news of manufacturing slow down.  Investors grew worried that bond insurers will have further difficulty with debt.  Bond insurers may not be able to pay all claims.  Bond insurer companies are being placed on review for downgrades.

Federal Reserve Chairman Bernanke testified before the House Budget Committee today, which was no more comfort to Wall Street.  The Chariman expressed deep concerns of our nations risks of economic downward spiraling.  He raised the usual concerns, meaning the same issues that have been looming for several months.  He did attempt to muster up some hope for the effectiveness of the fiscal stimulus idea the Congressional Budget Office released an analysis on a few days ago.

Bernake’s view on how fiscal stimulus might be effective might translate into something like this:

(a) a quick lump-sum rebate (of close to $500 per taxpayer and $1000 per household) similar to the one that was passed by Congress in June 2001; (b) temporarily extending unemployment insurance benefits; and (c) temporarily increasing food stamp benefits. A total package of about $110 to $130 billion, if approved quickly, would provide a boost to growth in the second and third quarter of 2008, and would lift 2008 real GDP growth by close to 0.5%. Global Insight assesses the odds of an effective fiscal stimulus package at just over 50% — there are high risks that the debate over the size and shape of the fiscal stimulus ultimately gets bogged down by the opposing political agendas of the Democrats versus the Republicans. –Brian Bethune, Global Insight

Chairman Bernanke believes this might provide some assistance in keeping the economy out of a recession.  Investors are still nervous and there is very little that a fiscal stimulus package will do to help that.  Housing starts are continuing to decline, a drop of another 14% was reported for December.  S&P fell 26.45 (1.93%).  Nasdaq fell 1.14%.

Wall Street is worried.

The Federal Reserve held its third TAF today putting a $30 billion 28-day credit up for banks in need of liquid funds. This is a $10 billion increase from the initial Term Auction Facilities held in December. Winning bidders are to be notified tomorrow, January 15, 2008.

According to Fed Chairman Ben S. Bernanke, the TAF was introduced as a means of extending the discount window.  He stated that the intention of the TAF was to address the issues “affecting the interbank lending market without complicating the administration of reserves and the federal funds rate.”  Bernanke also stated that “TAF auctions will continue as long as necessary to address elevated pressures in short-term funding markets, and we will continue to work closely and cooperatively with other central banks to address market strains that could hamper the achievement of our broader economic objectives.”

Basically, the banks need the cash flow to increase their ability to lend to one another and to borrowers. If the cash flow is not there, the economy suffers a credit crunch, and that’s what the Fed is trying to prevent.  The TAF may become a permanent tool that the Federal Reserve will use in this regard, according to the Chairman.

Fed Governor Mishkin discussed his views on monetary policy in his speech Friday. He says that to reduce macroeconomic risks, “…First, timely action is crucial when an episode of financial instability becomes sufficiently severe to threaten the core macroeconomic objectives of the central bank… Second, policymakers should be prepared for decisive action in response to financial disruptions… Third, policy flexibility is crucial throughout the evolution of a financial market disruption.”

These elements in policy development are, in Mishkin’s view, the appropriate approach to macroeconomic turmoil similar to what our economy has been facing. He stressed that monetary policy is very much science and the variables of economic data are important factors in policy changes and the response in macroeconomic turmoil.