Fed policy and the economy: Where are we, really?

The Federal Open Market Committee (FOMC) announced that it will continue business as usual with its asset purchase program ($40 billion per month in mortgage backed securities and $45 billion per month in Treasury securities) and interest rate policy (zero, until things pick up in the economy).  The most notable changes to the policy statement were the:

  • Slight downgrade of the economy (from moderate to modest)
  • Concern over the recent increase in mortgage interest rates 
  • The FOMC’s need to protect against inflation being too low and not just too high 

James Bullard of the St. Louis Fed had a small victory because of this policy statement because he has been the most vocal about making sure it’s clear to the public that inflation that is too low can be a problem and needs to be defended against.  This is why Bullard move from the “dissenter” side of the ledger to the “concurring” side.

The Fed’s policy statement is slightly more dovish than its June 19 statement.  That means cutting back on the asset purchase program looks to be a more distant dream than it did in June.

Gross domestic product (GDP) lifts, but growth rates don’t change much

For those of us who travel, it’s always important to know not only where you are going, but where you are starting.  The Bureau of Economic Analysis (BEA) released its revisions to GDP this morning.  The revisions go all the way back to 1929.  There were many technical changes, but the BEA basically began treating intellectual property (patents, copyrights, trademarks, and so on) as investments.  This had the effect of lifting GDP by about 3.4%.  The change effectively lifted the level of GDP, but didn’t change growth rates much.

First quarter 2013 GDP increased 1.1% (revised down from 1.8%) and second quarter GDP grew at a 1.7% annualized clip.  From the second quarter of 2009 to the first quarter of 2013, real GDP grew at an average annualized rate of 2.2%.  From 1929 to 2012, real GDP grew at an average annualized rate of 3.3%.  From 2002 to 2012, prices paid increased 2.3% annualized.

The short-term numbers for 2013 are far from the Fed’s projections of 2.3% to 2.6% GDP growth.  The Fed’s long-term projections of 2% to 3% GDP growth and 2% inflation look like low bars to cross.  Maybe the Fed is best described as being filled with short-term optimists but long-term pessimists, as the members are expecting growth to accelerate through the second half of the year and through 2014 and 2015.  However, growth is then projected to slow to something below the long-term average of 3.3%.

Looking ahead: Will current trends persist or improve?

As Niels Bohr, the Danish physicist, famously said, “Prediction is very difficult, especially about the future.”  Most forecasts are premised on the idea of some sort of reversion to the mean, or on the likelihood of current trends persisting into the future.  Both premises can prove to be deeply wrong.  I’ve been re-reading The Ultimate Resource, a great book by Julian Simon, who systematically addresses a lot of doom-and-gloom forecasts.  He was writing from the perspective of an economist in the 1990s (he died in 1998).  He has been accused of being a “cornucopian” who thinks that the future can always be better than the present. 

Over the long arc of history, he’s proven to be right, at least as it pertains to material well-being.  A lot of the improvements in material living standards have been due to innovative responses to periodic crises characterized by short-term pain but long-term gain.  This growth malaise—or crisis—we’re now in will likely play out the same way. 

Take these two examples: toilets and nutrition.  Billions of people on this planet haven’t even begun to experience the marvelous improvements in health from something as pedestrian as indoor plumbing.  Millions of Americans are also unhealthy because they’re obese but malnourished.  In both instances, a small improvement in health can have profoundly positive effects on growth rates and living standards. 

I’d be willing to guess that the next 50 years will see more rapid economic growth globally than the last 50.  At least, that’s what the long-view of the economic evidence points to.

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