Fed Takes a Dim View

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Fed Confirms Its Dimmer View Many commentators thought the 28-29 April Federal Open Market Committee (FOMC) meeting would be a non-event, believing the economy had not thrown up enough new information. The gradual exit, via tapering, from asset purchases continues with “only” $45bn per month now being added to the Fed’s balance sheet. April’s Employment Situation was broadly consistent with a recovery in labour demand, following weather-related noise in early-Q1. Meanwhile, the US economy grew just +0.1% in Q1 versus +2.6% in Q4. The weak headline data captured an inventory correction, but, even so, real final sales grew a paltry +0.7%. The desire to cut inventory in Q1 is understandable, given the recent uptick in the inventory-to-sales ratio to its highest level since 2009. Headline GDP data in Q2 is expected to be more robust, but it is unlikely to be a game changer for the Fed. The FOMC is no longer attempting to achieve faster growth, as testified by its decision to pursue tapering. Has the Fed lowered long-term US growth expectations? Lacklustre Productivity Produces Stagnant Economy? I have periodically commented on the view held in some circles that US potential GDP growth has stagnated, due to a combination of real and monetary factors. The important real factor is productivity, because it is crucial in linking economic growth to employment. In the UK, for example, productivity growth since the Great Recession has been appalling, but it helps to explain the faster-than-expected declines in unemployment, as well as the below-par recovery in corporate profitability. The post-Great Recession degradation in US productivity has not been on the same scale, but it can partially explain why weak output growth has been accompanie... ... middle of paper ... ...t of the US economy will be increasingly dictated by supply-side developments, particularly in the labour market. There is currently not enough unambiguous evidence of labour supply constraints to warrant a change in policy posture. The Fed has accepted that the lower participation is also being driven by structural issues, and not solely deficient aggregate demand. Former Fed Chairman cited in 2006 that the ageing US population would be a headwind to economic growth. Ageing populations means lower output growth. This has been spectacularly demonstrated by post-1990 events in Japan. An ageing population presents challenges to central banks, including lower sensitivity to changes in interest rates. Larger changes in policy rates may be required. The relative price of labour versus capital will also be affected, potentially producing financially unstable scenarios.

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