February 24, 2010

Long Period of Low Interest Rates

In his opening statement of the Semiannual Monetary Policy Report to the Congress, Fed Chairman Ben Bernanke emphasized that he did not plan to begin raising interest rates anytime soon given that the economic recovery would likely slow down later this year when government stimulus is withdrawn as expected in the coming months. 

Inflation is expected to remain subdued, with consumer prices rising at rates between 1 and 2 percent in 2010 through 2012. In the longer term, inflation is expected to be between 1-3/4 and 2 percent, the range that most FOMC participants judge to be consistent with the Federal Reserve's dual mandate of price stability and maximum employment.

The possibility of a deflationary threat has increased as indicated by the core inflation rate which fell by 0.1% in January, dropping for the first time in 28 years.  Assuming that economic growth remains subdued in the face of a challenging labor market and considering the possibility of further deleveraging in private and commercial real estate,  deflation could be a serious threat. 

Using an analogy by Paddy Hirsch, senior editor of Marketplace, the Fed stimulus in terms of interest rates looks like someone driving a car with the accelerator pedal almost pushed to the floor.  It does not appear that the Fed's ultra-low rate policy had much of an effect on the real economy so far and there is not much more the Fed can do to accelerate.  Is this Japan all over again?  Is this country prepared for a possibility that the S&P500 might be at or below 1,000 in 2010?


Click on image to view Mr. Bernanke’s opening statement.

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