Posted by: Michael Mandel on June 25
Is the Fed living in a fairy-tale world? Unemployment is rising, housing prices are plunging, and oil prices are sky-high. Oh, yes, and consumer expectations of their future economic prospects are at a record low, according to the Conference Board. The only sign of light is real consumer spending, which at least according to the official numbers, remains strong.
How can consumers keep spending,? No one knows. Yet the Fed has decided to believe in the cheerful official numbers, and stand pat, keeping the fed funds rate at 2%. In their statement today, the Federal Open Market Committee said
Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending….The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time. Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased.
Now, holding at 2% for one meeting is not a big disaster. It’s perfectly reasonable to wait and see what way the economy is going to go. And 2%, adjusted for inflation, is still equivalent to a negative real rate.
But it’s important to realize that it just doesn’t make sense that consumer spending should be firming up at this point in the cycle. What’s far more likely is that the official numbers are overestimating retail sales and consumer spending, and that the actual numbers have actually been on a downtrend (more about that in a coming blog post). There’s also a good chance, in my estimation, that we will see a sharp downward leg in spending, and an increase in savings, coming sometime soon.
What does that mean for the Fed? I still expect to see the fed funds rate drop as low as 1.5% in the near future, as evidence of the continued weakness in the consumer sector mounts, and starts to feed back into the banking sector. If consumer loan delinquencies keep rising, that will send a red flag up for Chairman Bernanke and his associates.
Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.