Federal Reserve & Interest Rates

Jean-Claude Trichet, president of the European Central Bank (ECB) gave a press conference this morning after deciding not to cut the key interest rates because of inflation concerns.

In his statement to the press, Trichet stated,

The latest information has confirmed the existence of strong short-term upward pressure on inflation. In fact, we are experiencing a rather protracted period of temporarily high annual rates of inflation, resulting mainly from increases in energy and food prices. The latest information also clearly confirms our assessment of prevailing upside risks to price stability over the medium term, in a context of continuing very vigorous money and credit growth. The economic fundamentals of the euro area are sound.

Trichet seems confident in the real GDP growth of the Euro-economy, and feels strongly that maintaining price stability should remain the main focus.  He believes that while there is uncertainty and turmoil in the financial markets, this approach will help maintain the European economy.  He also noted that there is an unusually high level of economic uncertainty.

Some experts say that the ECB could afford at least a small rate cut.  They have been incredibly reluctant to do so.  Over the last twelve months, euro consumer prices have gone up 3.5%.  The euro is currently trading at 1.5825 dollars.

The ECB voted to keep the interest rates high, rather than take the approach of the United States Federal Reserve and continuously slash rates.

There is a small chance of a global recession occurring at this point.  Monetary policy makers all over the world are now under pressure to make the right moves to help their regional economies.  It is no longer a question of whether or not the United States will pull through “tough times,” but a question of whether or not a number of nations will be able to avoid recession.

The latest Global Financial Stability Report was released by the IMF (International Money Fund) today, and there is news of world wide economic problems.  The credit crisis stemming from the subprime mortgage losses in the United States is spreading from mortgages to other corporate debt markets.  There are significant macroeconomic risks involved.

The executive summary of the Global Financial Stability Report stated that:

In sum, the global financial system has undoubtedly come under increasing strains since the October 2007 GFSR, and risks to financial stability remain elevated. The systemic concerns are exacerbated by a deterioration of credit quality, a drop in valuations of structured credit products, and a lack of market liquidity accompanying a broad deleveraging in the financial system. The critical challenge now facing policymakers is to take immediate steps to mitigate the risks of an even more wrenching adjustment, including by preparing contingency and other remediation plans, while also addressing the seeds of the present turmoil.

Economic losses could total over one trillion dollars combined.

Important financial institutions have to raise capital or reduce assets in order to cope with the crisis.  There are increased downside risks in global financial stability, and global economic effects could be serious.  Employment, output growth and bank balance sheets could be affected.  The credit breakdown in the United States is greatly tightening the liquidity of financial markets on a global scale.  This lack of liquidity and increasing credit problems in the U.S. could result in a world-wide credit crunch.

The report explains that overall risk management in lending practices were not handled realistically, and that “There was a collective failure to appreciate the extent of leverage taken on by a wide range of institutions.“  These institutions that failed to properly access risk and liquidity include banks and government sponsored entities.

In other words, millions of people who received credit a few years back probably should not have been lent the amount of credit that they were given.  People we allowed to purchase homes that they could not afford, and businesses did not profit as well as the thought they would.  As a result, the economy is suffering wide losses, borrowers are unable to pay debts, and now all of the closely tied international financial markets are being affected by it.

The Federal Reserve and the United States government have the burden of finding effective ways of boosting our economy.  If things don’t get better here, they will only get worse on a global scale.

It has been over six months since the Federal Open Market Committee began to cut rates to help our struggling economy.  Record job losses are continuing to be recorded month after month.  The housing market is continuing on a downward spiral.  There has been a major slow down in consumer spending, and in the growth of the Gross Domestic Product (GDP).  Even so, officials just won’t admit that our country is in a recession.

What more evidence do they need?  Chances are, the economy will get better before they actually admit that we “were in” a recession.  After seven months of a slowing economy, I think that it is safe to say that we are in a recession.  Officials are calling it “tough times,” but I am going to go out on a limb and call it a recession.  This is why I think we are in a recession now:

The financial markets are continuing to struggle, even though rates have been cut by nearly 3%.

So far this year, over 200,000 jobs have been cut.

The GDP moved at an incredibly slow pace of .6% for that last quarter of 2007.

The Consumer Price Index (CPI) is up by .3%.  Inflation continues to make gas and food more expensive.

Consumer spending dropped even through the holiday season, and has not recovered.

Businesses are cutting costs in whatever way possible, and are reluctant to invest in equipment, employees, and new ventures.

The trade value of the dollar has hit record lows against the Euro and the British pound, and hasn’t rebounded for months.

The Federal Reserve is pumping billions of dollars into the system, just to keep the credit market from totally collapsing.

The experts may not be able to see it, or admit it, but many Americans know that we are in a recession.  Just ask the millions that are in foreclosure, or are in danger of it.  Just ask the 7.8 million people who are unemployed right now.  Ask the struggling low income families that notice that food is more expensive to buy.  They will probably not hesitate to tell you that we are in a recession.

I don’t doubt that we will continue to see interest rate cuts for much of this year.  Bernanke expects the economy to pull through by the very end of the year, but the near terms are not looking good to even him.

I hope that we do pull through soon.