The Fed finally gets it right
For the third time in four months, the Federal Reserve (Fed) has cut the federal funds rate by one quarter of a percent. Fed chair Jerome Powell indicated that the current level of interest rates is probably right and that no further action is foreseen in the immediate future. This time, Powell got it right.
When President Trump was sworn into office, he made economic growth the top policy priority. This was very important, since the economy was experiencing the longest economic period of slow growth in history.
The economy hadn't seen 3% annual growth since 2005. The economy hasn't seen 4% annual growth since 2000. The primary reason is that the prior administration had set "curing perceived social injustices" as the top policy priority. Every time an action was taken to provide health care to more Americans or to stop banks from taking advantage of consumers, economic growth slowed.
In 2017, Trump canceled hundreds of growth-stifling regulations. That tended to increase economic growth. Also in 2017, Trump convinced Congress to cut taxes for all Americans and for corporations. That tended to increase economic growth. And Trump convinced Congress to repeal parts of the growth-stifling Dodd-Frank bill. That too tended to increase economic growth.
In 2018, economic growth accelerated to near 3% and would likely have gone higher had the Fed not raised interest rates. Saying they were fearful of inflation, the Fed's controllers raised interest rates eight times in 2017 and 2018. That tended to reduce economic growth.
In addition, in 2018 and into 2019, the Fed reduced the money supply by selling nearly half a trillion dollars' worth of bonds. That tended to slow economic growth.
Mostly because of the Fed's generally unfounded fear of inflation, its actions slowed growth just as growth was about to accelerate. The result was that after nearly 3% growth in 2018, the first quarter of 2019 saw more than 3% growth. But as the growth-reducing Fed policies filtered through the economy, growth slowed to 2% in the second quarter and slightly below 3% in third quarter.
Powell finally realized that there are three goals for monetary policy, not two. He forget to include the number-one goal. On numerous occasions, Powell said the goals of monetary policy are price stability and full employment.
Historically, the goals of monetary policy were growth, price stability, and full employment. Indeed, growth is usually listed as the number-one goal. Apparently, Powell has finally realized that, saying the Fed would "act as appropriate" to keep the current economic expansion on track.
In addition, Powell stopped selling bonds, which reduced the money supply. It appears that Powell is now doing the right thing. Inflation has been less than 2% for years and shows no sign of increasing. Apparently, the FED saw low inflation on the horizon. And why shouldn't it?
There is no fear of inflation from rising wages since productivity gains have exceeded wage gains, so labor costs to business are falling, not rising. In addition, the tax cut passed in 2017 was a supply side–oriented cut. That means that when demand in the economy increases, business will be able to meet the increased demand by increasing output rather than raising prices.
And since the U.S. has vastly increased the worldwide supply of energy, there is no fear of a spike in energy prices. That means little inflation fear.
The FED's actions this year will stimulate economic growth. Although the second and third quarters of this year saw 2% growth, there is some indication that growth will accelerate in the fourth quarter. With consumer confidence high, real increases in wages, low interest rates, stable money supply growth, and the beginning of a trade deal with China, the fourth quarter could see growth in the 2.5% to 3% range.
This is good news for retailers, who will see strong holiday revenues. This year, total Christmas sales will be 4% to 5% higher than last year. That momentum will carry into 2020.
The hope is that growth can really accelerate. Many of America's economic and some of its social problems can be tied to the long period of slow growth. We need to return to true economic prosperity, which means annual growth exceeding 4%. Let's hope that happens — and it should, unless the Fed overreacts again.